Self build mortgages

Self build mortgages, also known as stage payment mortgages, are another specialist type of mortgage that have seen a surge in popularity over the last decade, thanks to the rising number of people building their own home or undertaking a major renovation, extension or conversion project.

Around 10 percent of all homes built in the UK - and 1 in 4 of all new detached houses - are self build, with around 20,000 people each year building or renovating their own homes. This may seem like a lot, but the proportion is much higher in Northern Ireland and in many parts of mainland Europe, so it is fairly likely that this figure will grow in future.

Given that the average self-build project costs around £150,000, it is no surprise that over two-thirds of self-builders need long term-mortgage finance to fund their operations. The finance for this type of property is not as straightforward as that for a standard house purchase. You'd be advised to look into the availability and suitability of the different mortgage products at the earliest opportunity and arrange borrowing so that you know the money will quickly be available when you find your ideal site.

Despite the increasing propensity of UK citizens to build their own home, there are still probably fewer than 50 different self-build or stage payment mortgages on the market. These have varying features in terms of the maximum permissible LTV, underwriting policy, and the lender's attitude towards planning permission, building regulation approval and warranty. But the most important variation concerns the point at which lenders will release the funds. Some lenders won't release any money at all until the work is well underway, while others will advance the money to buy what is often the most significant expense - the land itself.

Who self builds and why?

There are a number of reasons why building your own home is a popular choice for many people:

For profit or for savings - the completed market value of a self-build property is typically 20-30 percent above the costs of development, meaning that self-builders are effectively buying their property at cost price.
To have full control over the choice of the location and positioning of the property.
To have greater input into the design and materials used, room sizes, dimensions and layout. This allows you to build house to suit a particular lifestyle, by adding extra bathrooms, a snooker room, a bar, a larger lounge or dining rooms etc.
To minimise tax expenses. Stamp duty is only paid on the land and even then only when the purchase price for the land is over £60,000. There is no duty payable on the cost of the build. Self-build also raises the possibility of reclaiming the VAT spent on the project. This is done at the end of construction and it is possible to claim for VAT on all goods and materials that are incorporated into the building or site, as long as they are bought from a VAT registered supplier.

There are three main types of self-build customers:

Those who want specialist help but also to have significant involvement in all the key design and construction decisions, but who won't carry out any of the work themselves. This is the most common group of people, with the self-builder acting as the brains of the operation.
Those who only need finance and are willing and able to carry out the whole project. This is more involved and sees the self-builder act as a hands-on project manager to liase with all third-parties and maybe even get their hands dirty on some of the activities.
At the other end of the scale, there are those who only want to make a few key design and construction decisions, leaving the day-to-day responsibility to other parties.

Arrears stage payment mortgages

An arrears stage payment mortgage sees funds for building works are released in arrears, on completion of key stages in the construction programme.

Lending will typically be between 75 - 95 percent of the cost of the build and some but not all lenders will make a separate loan provision to allow the self-builder to purchase the land on which the house will be built. In addition to the purchase of the land, the self-builder needs to be able to meet the costs of each stage of the building work before any money is received, which can often lead to serious cash flow difficulties with this sort of work. The cash flow situation is often worsened by the propensity for building and project management costs to escalate, which is why a slush fund of around 10 percent of the total cost is usually recommended.

Many self-builders sell their house to pay for the project, either moving into rented accommodation or a living in a caravan on site for the duration of the work. This is one of the most common routes to funding the project.

However, an increasing number of lenders allow you to stay in your own home while the building work is carried out, often by allowing a capital raising charge to be taken out on your existing property in parallel with a self-build mortgage.

If neither of these options is possible and the self-builder has insufficient capital from other sources, then short-term loan finance may be the only other option, but this is more expensive and should be a last resort. It is also worth considering whether the whole project is really that viable if you are having to opt for a last resort right to provide a solution to such a fundamental issue as funding.

The construction programme is normally divided into four equal stages, each representing 25 percent of the build costs. Funds are generally released on completion of the:

Foundations
Roof plate
Plastering
Remainder of the property

Each fund release is triggered by a re-inspection of the site and an interim valuation, for which there is normally a charge somewhere in the region of £50. This revaluation is really for the protection of the lender - they are not committing themselves to release the money until they are told by a professional that there is sufficient value in the property on the building site to support the additional borrowing. This pretty much guarantees that they could get their money back in the even of repossession.

Advance stage payment mortgages

Advance stage payment mortgages involve working out and splitting the cost of the land and the various stages of the building work an, with the money, up to 95 percent of the cost of land and build, being released at the start of each stage, with no money held back until completion of the build.

The addition of the land purchase makes for an extra stage in the build process when compared to an arrears stage mortgage and an extra interim stage is also often added for the wind & watertight protection, giving the following 6 stages:

Purchase of land
Preliminary costs and foundations
Wall plate level
Wind & watertight
First fix & plastering
Second fix to completion

The obvious advantage of this type of loan over an arrears stage payment mortgage is that the borrower has positive cash flow from the outset, as well as there being no quibbles about finding funding for the purchase of the land.

The positive cash flow makes the building process easier and quicker, as the labour and materials can easily be paid for when needed. There is also the advantage of not having to organise and wait for any interim valuations, as the lending is based on cost not on value. However, the lender still needs protection, so advance stage payment mortgages usually include a short-term valuation guarantee policy to protect the lender for the amount of money it has lent. The cost of such as policy is not that high - usually no more than the £200 or so that would otherwise have to be paid out for interim valuations with an arrears stage payment mortgage. This means that assuming there is no difference in interest rates, then there is little or no cost for having a positive cash flow.

Many people, particular those with young families, are put off building their own home by the thought of having to move out of their existing property and rent, stay with family, or even have to live on site in a caravan during the course of construction. It is not only the inconvenience of having to move but also the cost of doing so - the cost of moving twice, the cost of having to store furniture and it will generally cost more per month to pay rent than current mortgage payments. But with an arrears stage payment mortgage, it is almost always possible to stay in your own home, provided that you can afford to pay back this loan as well as your existing mortgage.

One of the biggest problems for would be builders is having the necessary cash flow to fund the building of the project, particularly if they have had to come up with the capital needed to acquire the land. But this problem is totally erased with arrears stage payment mortgages. The fact that this type of mortgage is much more suited to the way self-build is carried out means that they are likely to gain pre-eminence in the market place over arrears stage payment mortgages over the course of the next few years.

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