How to budget for a custom home

Key takeaways

• Construction loans work differently from traditional mortgages, with funds released in phases and stricter requirements, making early planning and lender communication essential.
• Land and site preparation can significantly increase total costs, often more than buyers expect, especially on undeveloped or challenging lots.
• Early design decisions help prevent budget overruns, as change orders, material fluctuations and delays are the biggest drivers of unexpected expenses.

One of the trickiest parts of building a custom home is carving out a budget that can cover all the unexpected construction costs.

"Buyers should understand that a custom home budget goes well beyond just construction," said Vinny Silva, president of VS Construction based in Boston, Massachusetts. "The main categories are hard construction costs, site work and land preparation, soft costs like design and permitting and builder fees. Focusing only on cost per square foot is one of the biggest mistakes, as it doesn’t capture the full investment."

When financing a custom home, buyers need to work with lenders to secure a construction loan or a construction-to-permanent loan. At the completion of the project, a construction loan can be converted into a mortgage.

"A construction-only loan covers the building phase of the home," said Daniel Cabrera, owner of Roof Direct San Antonio in San Antonio, Texas. "However, this loan has to be refinanced into a permanent mortgage once the home has been built. This means two closings and two sets of closing costs."

With a construction-to-permanent loan, the mortgage is built into the financing, so you only have to close once.

"In general, this type of loan is best for most custom homebuyers," Silva said. "However, the construction-only loan might be best for buyers who want to secure the best permanent mortgage rate available in the marketplace once the home has been built. However, buyers run the risk that interest rates may have risen during the building phase."

Funds from construction loans are released in phases. So, as the builder completes a portion of the project, they will request to draw more funds.

Similar to getting a mortgage, lenders will need to assess your ability to repay the loan by looking at your savings and credit score, but they will also need to confirm that the builders can deliver the project. So before you get a construction loan, you need to hire a builder and design a plan. Talking to a lender first helps you gauge what you can afford.

Once you understand the scope of your budget, you need to find a builder who can work within that budget.

"A builder should be brought in before design begins," Silva said. "The most successful projects are when the builder, architect and client collaborate from day one. That allows the design to stay aligned with the budget and avoids costly redesign later."

Talk with builders and put together a plan for what you want. Discuss the design, materials, finishes and timeline.

"Ask each builder to provide a line item breakdown of costs, rather than a lump sum bid," Cabrera said. "Compare costs category by category, from foundation to roofing, mechanical, finishes and allowances. Be sure to pay close attention to what is included in allowances for things like lighting, flooring and appliances, as a low bid with low allowances means costly upgrades later on."

Then you will need to find a place to build.

When budgeting for the land, there is more to consider than the parcel's sale price. If the land is truly undeveloped and remote, connecting the home to utilities and roads could cost much more than for a piece of land in an urban setting. Land with lots of rocks or hills could be hard to build on as well. Choosing land goes beyond location and looks; it should also be fiscally reasonable.

"Land preparation can significantly impact the budget and is often underestimated," Silva said. "Costs can vary widely depending on soil conditions, topography, drainage requirements and how far utilities need to be brought to the site. In some cases, this can be one of the largest variables in the entire project."

Builders will be able to advise you on whether a piece of land will be cheaper or more expensive to prepare. Unexpected costs could still arise, but having a professional can help mitigate surprises.

With land and builder, return to your lender to secure a loan.

"The lender will order an appraisal based upon the plans and specifications to evaluate the projected value of the completed home," Cabrera said. "They also compare the construction budget to local cost per square foot benchmarks to make sure the numbers are reasonable. If the budget appears inflated or unreasonably low, this also serves as a red flag."

Some builders have a recommended lender they work with. Working with a builder’s lender could make the approval process easier, but be sure to investigate the lender's validity. Compare interest rates, fees, draw schedules and customer reviews, and confirm the lender has experience with construction loans and strong communication practices throughout the build.

"In addition, the lender evaluates the construction schedule to make sure it fits within the loan term, which is generally a 12-month term for the construction phase," Cabrera said. "An organized builder with clean documentation makes the lender's task much easier and more likely to get approved."

Once financing is secured, buyers should track construction progress and loan draws. After site preparation, the next draws typically cover the foundation, framing and mechanical systems.

"They are paying in stages, or draws, based upon the stages of construction, such as completion of the foundation, completion of the framing, dry-in, mechanical rough-in and final finishes, to name a few," Cabrera said. "Before a draw is paid out, an inspector is sent to make sure that the work that was described in that draw request is indeed complete. This is to safeguard both the buyer and the bank so that they are not paying for something that is not yet done."

The longer a project takes, the more expensive it will be, as you are paying for more labor hours. Building a home can take anywhere from six to 18 months.

"Buyers should plan for some level of fluctuation by building in contingency, making key decisions early and working with a builder who actively tracks pricing," Silva said. "Long delays between design and construction can increase exposure to market changes."

To stay organized, buyers should ask for an itemized expense log.

There are dozens of variables that can impact the cost of building a custom home. The best thing you can do as a buyer is make up your mind early on what you want in the house.

"The best advice I have is to make all of your design decisions ahead of time, prior to construction, so that there are no change orders during the construction of your project, which is by far the largest cause of budget overruns," Cabrera said. "Decide upon all of your finishes, fixtures, appliances and landscaping ahead of time and make sure they are included in your contract with your builder."

Buyers should also ask builders which design elements drive costs.

"Cost is driven more by complexity than size," Silva said. "Things like complex rooflines, large structural spans, oversized windows and high-end kitchens and bathrooms can increase costs quickly. The best way to manage this is to simplify the structure while being intentional about where to invest in standout features."

Material prices can fluctuate with the market, and some adjustments may be needed to stay on schedule. Weather delays can also affect timelines, so budgets should account for them.