How to pay for your dream house

Construction loans also differ from mortgages in that they don't pay out all at once. Lenders typically dole out your funds in five to 10 "draws" timed to various stages of construction, such as:

• Grading the site and pouring the foundation

• Framing the house

• Installing heating, air conditioning, plumbing and wiring

• Finishing the exterior

• Installing drywall or other interior surfaces

• Installing cabinets, fixtures and trim

• Interior painting and other finishing touches

The money is typically paid after each stage is completed, not before -- although some lenders recently have loosened up on this standard, said mortgage expert Razmik Vartanian of Mark 1 Mortgage, by disbursing just enough money to cover deposits on supplies.

Construction loans also differ from mortgages in how lending companies determine how much you can borrow. Conventional mortgage lenders base their loan maximums on the current value of the property and loan 80% to 90% of that value. Construction lenders, by contrast, may use the estimated future value of your property -- what the home will be worth after it's completed -- or may base the loan on how much the project is expected to cost.

Containing your costs

Say you found a lot for $100,000 and plan to spend $200,000 designing and building your castle. The lender might require $5,000 in loan fees, plus interest and contingency reserves of about $20,000. The total loan would be for $260,000 -- 80% of $325,000.

Don't expect to cut costs by acting as your own contractor unless you've had significant experience in construction. Most lenders insist that borrowers hire a professional contractor.

"I have done a few construction loans for borrowers that had experience building and acted as their own contractor," said Bond of Palos Verdes Funding in California. "The lender needs to have the confidence that they have the experience to handle the job."

The best way to contain costs, home remodeler Christensen said, is to plan carefully and stick to your plan, because it's so easy to get carried away. Suddenly you're spending $1,000 on spa tub faucets and upgrading every surface in sight -- only to run out of money before construction is finished.

"It sounds funny, since this is your dream home, but you really do have to rein in your desires," Christensen said. "You need a little self-censorship."

Liz Pulliam Weston's latest book, "Easy Money: How to Simplify Your Finances and Get What You Want Out of Life," is now available. Columns by Weston, the Web's most-read personal-finance writer and winner of the 2007 Clarion Award for online journalism, appear every Monday and Thursday, exclusively on MSN Money. She also answers reader questions on the Your Money message board.

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