Everything You Need to Know About Construction Mortgages in Canada
When it comes to shopping for your dream home or finding the right cottage property,
it could take months searching all over town for a house that is just the right one for you, only to come up empty-handed. Why?
Inventory is famously low these days and often, re-sale homes may not be affordable. When they are, they can look great from the outside but upon inspection, they are riddled with problems. Instead of going through all this hassle, as a homebuyer, a better option is to choose construction mortgages. A construction mortgage will help you borrow money to have your own home constructed for you instead of buying an existing home. Thus, you will have the complete freedom to build your home from the ground up, just the way you want it done.
How do construction mortgages work?
Construction mortgages are short-term financing for new home builds. They are also called draw mortgages based on their nature of advancing funds in draws rather than all up front. Your lender provides the funds to your lawyer who disburses the funds to the contractor. Sometimes, the lenders might also deal directly with the contractor.
Draws are paid in stages. Thus, the contractor doesn’t get the complete amount upfront. Instead, they get the money proportionate to the completion of the construction of the home. Thus, you can rest assured that the loan funds are actually used towards the construction of the home.
Most lenders lend 75% of the construction cost so you have to pay 25% of the construction yourself. Generally, you need to own the land although if a lender sees you have a plan to build a home on that new piece of land, the 75% funding rule applies on land value and construction combined. If you are not using any contractor or a home builder, then you can also opt for the self-build construction loan that offers financing to build your home yourself.
Details on construction draw schedules
The construction draw schedule will outline when the construction draws will be paid. The draw schedule will be negotiated before construction. The bank has its own draw schedule but some contractors also propose their alternate payment schedule. This is due to differing construction timelines or costs.
You can schedule construction costs according to milestones like when the foundation or the roof is complete or a certain percentage of the total home is finished. The interest rates only start to incur when the construction draw is disbursed. Being a borrower, you might want to get draws as late as possible because it will reduce the rate of interest during construction.
On the other hand, the contractor will want to get their payment as fast as possible. In case the constructor or lender proposes an alternative payment schedule, you have to review it to make sure that it allows your contractor to be paid on time and it also should be reasonable.
Live Construction Financing Example with Typical Draw Schedules
Land value of house: $200,000
Construction Costs: $800,000
Total funds needed: $1,000,000 ($800,000 + $200,000)
At 75% Loaning Maximum, $750,000 is lent to you. You need to contribute a $250,000 down payment.
Three Main Draws: 12 month deadline:
First Land Draw Stage: Based on 75% of land value, you get a $150,000 Loan. $50,000 is needed up front by you
Second Framing Stage: Some lenders require this second stage to ensure the framing of the home is complete. This is typically where a home's construction is 20% complete. On a $800,0000 build, the home has $160,000 invested so far with 75% financed ($40,000 invested by you and $120,000 from the lender).
Third Dry Wall/Lock Up Stage (windows and roof are built): The lender budgets enough money to build out the windows and roof and until they are built and approved by an inspector, they generally withhold the rest of the financing. However, in some instances, you can still get some draw money for the rest of work not completed yet.
Fourth and Final Completion Stage: Full amount released after all work has been completed.
The number of construction draws you can receive
Most lenders like banks allow up to four draws. Other lenders are more flexible and they allow a higher number of draws. Your lender will send an appraiser to check the progress of the home before any draw is paid. There is an inspection fee of about $100, charged every time depending on the lender. While construction is happening, you generally pay an open interest rate of Prime Rate + X% on the total incremental amount borrowed (e.g. 2.45% + 1% = 3.45%).
Monthly payments on construction loans
You have to make monthly payments on the construction loan even when the construction loan is ongoing and you haven’t occupied your home. There are some lenders who would need only monthly interest payments throughout the construction. You have to pay the principal amount when the construction is complete.
Construction loan eligibility
Construction loans need you to put up money upfront to pay for the construction expenses. To check whether you can afford a construction loan and afford a mortgage, the lender will check your income, credit score & debt levels.
THE BOTTOM LINE
Building instead of buying a home is becoming more of a consideration as inventory stays low and people start to work remotely in a post pandemic world. Building isn’t easy and has some risks. You firstly need a large up-front payment to buy the land first or, you can mortgage it and the property at once. If you choose the wrong contractor and there are delays, you’ll be in a tough cash crunch since lenders advance money in four draws with strict completion criteria. Your first step to assessing whether a construction mortgage approach makes sense for you is to ensure you have the minimum down payment needed based on projected construction costs, alongside an emergency fund in case contractors go over budget or there are delays in mortgage draws.
See what you qualify for or contact Paul to get your pre-approval.
Paul Davidescu (www.levelupmortgages.com)
Level Up Mortgages
604-809-3188
paul(at)levelupmortgages.com
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