Self-build mortgages - where to start
Every year, thousands of people in the UK successfully self-build and with log homes coming under this heading and new government initiatives making self-building easier, it is an exciting time to be considering your own. If you’re planning to borrow from a mortgage lender to finance your project, it is worth being aware that the process is a little different to the more familiar conventional mortgage route. Neither mortgage process is without complexities and although a little dry, bear with us - it’s all useful to know!
Self-building in the UK
Although traditionally self-build financing has been relatively difficult to access compared to conventional mortgages, lenders are increasingly open to this method of construction helped in part by government initiatives aimed at increasing the self-build rate in the UK from the 13,000 properties in 2017 to 20,000 a year over the next few years. The UK, where only 7-10% of homes are ‘self-built’ each year, is currently lagging behind much of the world when it comes to self-building. In Canada this is as much as 50% and Austria, the world leader, 80%! But with more and more people looking to design and build their own homes, accessing funding is getting easier with more lenders seeing self-build as a viable route to home ownership.
Just as there is no VAT payable when purchasing an existing building, as long as your project is intended for use as your primary residence and not for business use (including holiday lets), the good news is that VAT costs on materials and labour can be reclaimed and zeroed out. This can make self-building your dream log cabin financially more economical than modifying an existing house to your needs.
Whilst the risks to a lender remain relatively high with all the unknowns of self-builds, and 25% deposits and higher interest rates are normal, you may only be tied into your self-build mortgage while your house is being built. On completion some lenders will allow you to remortgage onto a standard mortgage with a lower interest rate.
How do self-build mortgages differ to normal mortgages?
The first and perhaps most fundamental difference comes not from the mortgage, rather the project itself. For the majority of self-build mortgage applicants the project is still in the planning stages and doesn’t physically exist at the time of application. This is different to purchasing an existing property where building timeframes, costs and unexpected hiccups along the way are not part of the equation.
Mortgage lenders are still going to need to see and assess the potential end value of your project but, as part of the affordability study, they are going to look more closely at your living costs while the log cabin is under construction; are you going to be renting or paying an existing mortgage while your project is being built? If so, for how long and at what cost? Who is funding that and how? What happens if the build runs over schedule or cost? These things will need to be planned and budgeted for as part of your self-build mortgage application, but this is also a good exercise to factor into your own build planning diligence. If you haven’t done so already this might be a good place to start.
The second fundamental difference is that funds from self-build mortgages are typically released in stages, before or after each identifiable step of the build. Funds released before the start of each phase are known as Advance Stage Payments whereas those paid out on completion of each phase, and usually subject to interim valuations by the lender, are known as Arrears Stage Payments. Each comes with its own pros and cons so it is worth being familiar with the differences. These differ to a conventional mortgage where funds are released in a single lump sum allowing you to complete the transaction in one go.
What are the differences between Advance Stage Payment and Arrears Stage Payment mortgages?
Advanced Stage Payments as the name suggests are paid to you before the start of each phase of your log cabin, having been agreed in advance by your mortgage lender based on confidence in you as a customer and the end value & timescales of your project. Although fewer lenders offer this option, if you can secure this type of loan, it means your payments are guaranteed to arrive before you have to pay out suppliers and contractors. This puts you in a cash-rich position throughout the construction process giving you greater peace of mind and overall control of proceedings. It may mean however that your mortgage repayments begin before construction is complete so you need to factor this into your outgoings.
By contrast, Arrears Stage Payment mortgages are paid out in installments on completion of predetermined phases of the build and are subject to a satisfactory valuation on the work that has been carried out. Such mortgages typically occur when the end value of your project is difficult to establish at the outset and periodic checks are required to ensure the value of the project is increasing over time. Lenders will therefore assess the value of your log cabin throughout the life of the project to ensure they are not over-lending against it at any stage of the process.
Arrears Stage Payments mean you personally have to pay your suppliers and contractors before you receive any money from the mortgage lender. This may not be a problem if you have savings to fund each stage, but problems can arise if a valuation comes back lower than you were expecting resulting in the bank releasing less money than you may have accounted for. Arrears Stage Payments are therefore not guaranteed and again repayments may begin before your project is complete but if you are confident in your finances and cash flow, this may find this a more ready source of additional funding.
We always recommend you speak to a qualified self-build mortgage advisor to discuss all the options available to you before you commit to either type of loan.
Do I need anything different for a self-build mortgage?
The application process for a self-build mortgage is a little more complicated than that of conventional mortgages simply because there are more unknowns. You will need to demonstrate a scheduled build plan that clearly demonstrates realistic timeframes, expected costs (including your living costs throughout the build), financing requirements and anticipated final valuations.
As even the very best builders cannot fully guarantee there won’t be defects in the materials used (particularly when using natural materials such as wood) or their workmanship, you are also likely to require Structural Warranty Insurance which typically covers such defects for the first 10 years of your new log cabin. This insurance reduces the risk burden on the mortgage lender and makes your property easier to sell in the future. As such, many lenders will want to see a certificate of Structural Warranty Insurance in place before they will lend against a project.
You will also need to show that you have received planning approval for your log home. Additionally given the perceived extra risk associated with unbuilt projects, most self-build mortgages require a deposit of at least 25%, compared to the typical 10% of a conventional mortgage.
What is the Right To Build scheme?
Passed as part of the Housing and Planning Act 2016, the Right to Build scheme requires local authorities in England (only) (with Wales launching its own Self Build Wales scheme in early 2021) to make land available to those looking to self-build and requires such demand to be taken into account when considering larger planning applications. If you are looking for land, register with your local authority Right to Build Register where you will be able to read more about your local application process, availability and any restrictions. At the time of writing, Scotland and Northern Ireland do not have such schemes in place, but with demand for the self-build option increasing all the time it is unlikely to be long before they follow suit.
Although this may all sound like a lot of hoops to jump through, remember that thousands of people in the UK successfully self-build each year so don’t let a little bit of paperwork stand between you and your dream log cabin!
DISCLAIMER: This article is given in good faith and is intended as nothing more than a general overview of the UK self-build mortgage landscape as of April 2021. No part of this article shall be interpreted as formal financial advice and we highly recommend seeking the advice of a professional mortgage advisor when planning any type of mortgage. It remains the responsibility of the client to ensure all legal requirements are met before embarking on a build.