There are a few things you ought to know before you build a home. If you’ve bought real estate before, then you are familiar with the idea of an Earnest Money deposit. It is essentially collateral money on a contract to buy a home. In other words, if you are unable to buy the home, there is a chance that the seller would get your Earnest Money.
However, if you contract to build a new house, you will usually be required to pay both a Construction Deposit and an Earnest Money deposit, and sometimes other deposits as well. What are the differences, and why the additional costs?
It turns out that there is a little more to Earnest Money than most people realize. It isn’t just money that the buyer puts at risk, but it is also the amount that the buyer can get from the seller if the seller defaults. In other words, if you try to buy a house and the seller backs out, not only would you get your Earnest Money back, but the seller may also have to pay you that much money again.
Sellers in a hot market—like we have right now—usually want to see a large Earnest Money deposit. This shows that the buyer has financial strength, and that they are serious about the deal. But, when the home being sold hasn’t been built yet, there are more problems that could cause a default. That means that developers are more likely to have to pay out. Also, developers build a lot of houses, which multiplies the chance that they might have to pay out. Lastly, Earnest Money usually can’t be used for construction. It just sits in the bank until closing. All these reasons are why developers will often ask for very small Earnest Money deposits, perhaps only $500.
However, developers, even more than normal sellers, want committed buyers. So instead, they will usually require other kinds of deposits that give them more control and less risk. The terms of these deposits will vary, and are usually designed to protect the developer, not you as a buyer. This is one more reason that it is helpful to have a qualified agent representing you when you build a new home.
What are some of these deposits?
Construction Deposit: This is usually a fairly large sum of money that you are required to pay to the developer before construction begins. Like Earnest Money, this money counts towards the total cost of buying the home. However, it is often non-refundable or only partially refundable. It’s a way for the developer to ensure that you are committed to building a home, without increasing the amount of money they might have to pay you if there are problems.
Construction Deposits also cover the initial cost of construction. This is important because construction loans are expensive, so delays in getting a house sold (like you backing out of the deal, or having a hard time getting a loan) cost the developer a lot of money. The last thing they want is to spend money at a high interest rate and then not have anyone to buy the house. The Construction Deposit gets them through the early part of construction without any expenses. If all goes well, by the time the debt payments are getting high, you have bought the house so they have money to pay their debts. This makes it safer for them and for the bank, which makes building homes more affordable.
It also means that, most of the time, you will need more cash if you want to build a home than if you were to buy an existing home. There is no such thing as 100% financing when you build a new home. You will need some cash up front.
Lot Deposit: This lets you pick the lot (the piece of ground where the house will be built) you want while you finalize decisions about the house. It also gives you a little time to make sure you have (or can get) the necessary Earnest Money and Construction Deposit. It is usually partially or wholly refundable, and is usually the first deposit you pay (often before you even know what house you will build or sign a contract to build it). The good news is, it usually gets converted into your Earnest Money or added to your Construction Deposit after you sign a contract.
At the same time, it helps the developer to know that they aren’t wasting their time with someone who hasn’t got any money, or who isn’t serious.
In a busy market, like we have right now, people often have to make quick decisions. This can be hard when you are building a new home. You are spending hundreds of thousands of dollars and have a lot of details to figure out. A Lot Deposit Gives you some breathing room. It lets you hold your place in line while you make sure what it is you want, and that the developer really can build you the home you want at a price you can afford.
Fees: These are not a deposit, but rather are a fee you pay for extra work that that needs to happen before construction begins. They are usually things that the developer can’t sell if the deal falls apart. They only have value to you for this deal, so you have to pay them up front.
They might include Design fees (for example, if you want to change the floorplan), Design Review Fees or HOA Review Fees (if changes need to be studied by the developer, City or HOA, and approved before construction can start), or permit fees (which cover the cost for the city or county to inspect the work being done). Custom homes may include any number of other fees including less common things like environmental impact fees, infrastructure impact fees, and many more. Building a custom home is a much more complicated topic, and we’ll discuss it, and its fees, in other articles.
In conclusion, when you build a home, you should expect to have to pay more deposits, which add up to a lot more money up front than if you were buying an existing home. Also, there are more conditions to be aware of on your money, and it is always a good idea to have help to make sure things go well. If you are interested in learning more, check out our other articles, or call RPA Realty at 801-910-4125 to speak with an experienced agent.