Yes, it's a valid way to do it. Usually, though, the builder will recoup the interest he has paid on the loan by increasing the cost of the house. You will still need to make sure you have at least 20% equity in the build to get the mortgage without PMI.

Just to clarify as well--are you thinking you have to have 30% right now with 20% to the bank & 10% to the builder? It's my understanding in dealing with a few different banks that they require you to have 20% invested in the house and they will finance up to 80%. You hang onto your 20% and you pay the first 20% of costs directly to the builder. (So pay him 10% up front to get started and then the builder should provide itemized receipts to you showing where the money went & whether you're on budget so far. When you've exhausted your personal funds for the project, the builder will go to the bank for his future draws up to the agreed upon maximum loan amount. Any costs over and above that are your responsibility. Before you close/convert the mortgage, you will need to bring in the itemized receipts showing what you paid for and how much the expenditures were. This is your proof to the bank of your having invested the 20%.

Hope this helps!

We're doing this now. Put 10% down and signed a fixed price contract with a few common sense clauses to protect the builder from unforeseeable expenses (land, septic, backfill.) Then when it's done we'll get a conventional mortgage and put down however much more we can.

I think it's a great deal and it seemed that not all builders were capable of carrying the loan. But yes, the interest only payments are likely rolled into the contract price somehow I assume.

We had a builder that did this as well. One of the most reputable in town. They did it this way but only had a handful of plans to choose from.

That only works if you don't keep upgrading everything and have to pay for that as you go along. And, it also only works as long as the completed home will make the appraisal. Any other scenario, and you'll need to spend money that you obviously don't have. If the finances are tight, the finances are tight. There is no magic way around it. An 800K house will still be an 800K house, only it might cost you 900K to build by the time you get through building it, and the appraisal might come in at 710K. It's a total crapshoot when dealing with a bank in today's lending climate. The only control you have in the situation is to not make any changes at all once construction begins.

If you are on the edge financially to build, then it makes so much more sense to shop for something that already exists. It's at least 20% cheaper in most markets in the US now (not all), and in some markets, it's as much as 50% cheaper. THat 800K house might cost you 400-650K then.

As a builder, I've done a number of homes that way on a fixed-price basis. However, if you decide to upgrade from what you agreed on, there's no upper limit on what you can spend. And it adds up quickly. Unfortunately, I have no silver tongue, so I usually end up with nothing extra.

We've done this on a couple homes. Any change orders (upgrades) during the build, I paid in full at the time.

When our house price was more than the appraised price (which was expected,) we had to pay the difference to be able to close.

The problem with this is that if budget is that tight, and you don't appraise (which happens a lot), you will have to bring money to the table to close - like lolauren says.

This can happen even if your builder stays on budget and you don't upgrade. I would be wary of doing this if your up front money is as tight as it seems.

I think you should talk to the bank about this in more detail. We are putting 20% down directly to the bank, and the downpayment and costs for the builder will come directly out of the construction loan, you can even buy the lot with a portion of the construction loan.

Then, while you are building you make interest only payments that build as the costs get billed to the bank.