Self-Build Mortgages: What They Are and How to Get One

Mr A

What Are Self-Build Mortgages?

Self-build mortgages are specialized mortgage products designed for individuals who want to build their own homes. Unlike traditional mortgages, which provide funds to purchase an existing property, self-build mortgages release funds in stages throughout the construction process.

Key Features of Self-Build Mortgages:

Funds are released in stages as the building progresses
Higher interest rates compared to traditional mortgages
May require a larger deposit (often 25% or more of the total project cost)
Must provide evidence of planning permission, construction plans, and cost estimates

Advantages of Self-Build Mortgages

Greater control over the design, layout and quality of your home
Potential to save money by acting as the project manager and sourcing materials yourself
Often results in a home with a higher value than the cost of construction, creating immediate equity

Understanding the Application Process

Nor every financial institution offers self-build mortgages, so it's essential to find lenders who specialize in these products. The process to apply for a self-build mortgage is more complicated than a traditional mortgage and may require additional documentation.

The Application

As with regular mortgages, the applicant must provide personal and financial details, including income, credit history, and outstanding debts. Lenders will assess the applicant's ability to repay the loan and the project's viability.

Planning Permission and Building Regulations Approval

A key prerequisite for a self-build mortgage is to obtain planning permission and building regulations approval. Lenders will require evidence that these permissions are in place to ensure that the project is legal and adheres to local regulations.

Detailed Construction Plans and Cost Estimates

The applicant must provide detailed construction plans, including architectural drawings and specifications, and an itemized cost estimate for materials and labor. Lenders will use this information to assess the project's feasibility and predict its final value. This is particularly important because the lender wants to ensure that the finished property will have a sufficient value to secure the loan.

Deposit and Loan-to-Value (LTV)

Self-build mortgages typically require a larger deposit than traditional mortgages. The loan-to-value (LTV) ratio for self-build mortgages can vary, but a 75% LTV is fairly common – meaning the borrower must provide 25% of the project's total cost as a deposit. In some cases, a higher LTV may be available, especially for more experienced self-builders or those with significant equity in existing properties.

Construction Experience and Managing the Project

Lenders may inquire about the applicant's experience in construction or project management. This is because self-builders must be actively involved in managing the project, and prior experience may be seen as a positive factor. It's important to emphasize any relevant experience or qualifications during the application process.

Mortgage Product Types and Interest Rates

Self-build mortgages come in various product types, with interest rates generally higher than traditional mortgages.

Variable Rate Mortgages

A variable rate mortgage has an interest rate that can change during the mortgage term, usually linked to the lender's standard variable rate (SVR) or an external benchmark such as the Bank of England base rate. Variable rate mortgages can have lower initial interest rates, but they carry the risk of increasing rates, leading to higher monthly payments.

Fixed Rate Mortgages

A fixed rate mortgage offers a predetermined interest rate for a specified period, usually ranging from 2 to 5 years. This provides certainty regarding the rate and monthly payments but may carry a higher initial interest rate compared to a variable rate mortgage.

Tracker Mortgages

A tracker mortgage has an interest rate that tracks a predefined market rate, such as the Bank of England base rate, typically with a margin added by the lender. The result is a mortgage rate that fluctuates with market conditions. While tracker mortgages can offer lower initial rates, they can also increase if market rates rise.

Interest-Only Mortgages

In some cases, lenders may offer interest-only mortgages for self-build projects, which require the borrower to pay only the interest during the construction phase, and then switch to a repayment mortgage once the property is complete. This option can lower initial payments, but the borrower must ensure they can afford the higher payments once the capital repayment begins.

Funding Stages and the Arrears vs. Advance Conundrum

Funds for self-build mortgages are typically released in stages as construction progresses, with lenders sending a valuer to assess the project's progress before each stage payment.

Arrears Stage Payments

Arrears stage payments are released after each stage of construction is completed and verified by the lender's valuer. While this approach may be more budget-friendly for lenders, it requires self-builders to have sufficient cash flow or access to other funding sources to cover the costs until the stage payment is received.

Advance Stage Payments

Advance stage payments are released at the beginning of each construction stage, giving the self-builder access to funds upfront. While this can ease cash flow issues, it can also result in higher interest rates from the lender and a lower overall loan-to-value ratio.

How to Increase Your Chances of Securing a Self-Build Mortgage

Securing a self-build mortgage can be challenging due to the added complexity of the project and financial requirements. Here are some tips to increase your chances of success:

Plan ahead – Ensure you have planning permission, detailed construction plans, and accurate cost estimates before applying.
Have a sufficient deposit – Save for a larger deposit, as self-build mortgages often require a higher LTV.
Improve your credit score – Take steps to improve your credit rating by paying bills on time and reducing existing debts.
Demonstrate construction experience – Highlight any construction or project management experience to increase lender confidence.
Be prepared to compromise – Be willing to adjust your home design or specifications to fit within your budget and lender requirements.

Conclusion

Self-build mortgages offer individuals the opportunity to create their dream home while potentially saving money and building equity at the same time. However, they do come with additional challenges, including higher deposit requirements, more complicated application processes, and staged funding.

Understanding the various mortgage product types, the importance of planning and preparing ahead of time, and the stages of funding can improve your chances of securing a self-build mortgage and realizing your dream of building your own home.