When you get a mortgage that covers the construction costs of your home, this is called a construction mortgage. This type of mortgage various from other mortgages in several ways.
- The Completion Mortgage
- The Draw/Progress Draw Mortgage
- Construction Mortgage and the Land
- The Vacant Land
- The Process of Getting a Mortgage
The Completion Mortgage
When you buy a home, there are two different mortgage types. The first type is called the completion mortgage, and this is a loan that isn’t transferred until all the construction is done or until you take possession of your home. You usually have to supply the down payment, but it can sometimes be done with installments. The payment usually isn’t made until the construction is done so changes to the mortgage can be made up to 20 days before you take possession. Mortgage changes might include more money for additions or upgrades that you decide upon.
The completion mortgage can put your mind at ease since your mortgage isn’t going to be finalized until you have possession. The downside is that you have some uncertainty that something could take place in the meantime. This is fine if it’s a delay in construction but not so great if its something on your end such as a life emergency or job loss. This sort of thing might delay the mortgage approval or stop it altogether. This means that you have to decide if you want a completion mortgage or not as there are some pros and cons to it. The plus to this type of mortgage is that most lenders will want the building complete in 120 days, so you have plenty of time.
The Draw/Progress Draw Mortgage
Another type of construction mortgage is referred to as a draw or a progress draw mortgage. During the building process, this mortgage allows the builder to take out money. During this type of mortgage, the loan will be dispersed in increments. The first one is when the build starts and then the second when the build is at 35-40%, the third at 65-70% and a final one when the build is close to 100% complete. These stages are referred to as foundation, the lockup, drywall, and finally the complete stage. If you’re building your own home and need money as you build, you can also apply for a progress draw mortgage.
In terms of cash flow, the progress draw mortgage can be very beneficial. The builder doesn’t have to have the money right away before the build begins. An inspection will have to be made during the build process to ensure that things are done correctly and on schedule. If the build doesn’t pass the inspection, then the next payment isn’t available to the builder. The builder will have to pay a fee each time the appraiser comes to look at the progress of the building. During the progress draw, mortgage interest may be charged from the date of the first payment and you can’t make any changes to the mortgage once approval for the initial payment has been made by the lender.
Construction Mortgage and the Land
The land is used to secure the construction mortgage and the improvements combine with the land value to make up the total project value. If the land has no mortgage or a small one, the builder can get the first draw of the financing right away which is called the foundation draw. If not, you will be required to supply the cash on your own until the first loan disbursement which is around 30-40%. If you’re motivated to build your own home to keep costs down, you must remember that you will need a lot of money upfront. Those that work with construction on a regular basis know that renovations and construction work understand that construction costs tend to go up during building. Unforeseen circumstances, planning, and labor cost all factor into overall construction costs.
The Vacant Land
If you’re starting a construction and you need a loan to purchase the land, then a different type of loan might be required to buy this land. This won’t apply if you’re buying your home through a builder. If you have good credit and a steady income, the vacant land may still come with 25-35% interest rates and you will require a larger deposit. Another way to get a loan for private land is through a private lender or by using a personal line of credit or home equity line of credit or you can use the equity that you have invested in another property.
Whenever you buy land you need to do some due diligence to determine if you’ll be allowed to build the property that you want on the land. Some things to factor in include wastewater removal, water source, environmental concerns, land zoning, land partitioning, utilities, and how close the land is to amenities you might want to use.
The Process of Getting a Mortgage
The process of getting this type of mortgage can be more involved when compared to other mortgages. Some lenders have time limit restrictions and won’t loan you money if the build goes past a date that they specify. The lender may also require that you supply estimates for the cost of construction this may include the land costs if you haven’t already purchased this.
In some cases, you may be restricted to the builder you’re allowed to work with. Builders may need to be registered under applicable provincial laws. Some lenders may require that the builder has a decent build record and that they can provide a fixed price for the project completion. If you’re planning to build the home or intend on hiring a contractor, then both of you must have the ability to complete the home.
A completion mortgage usually isn’t a problem for a lender as the loan won’t be finalized till the home build is done. The lender has around the same amount of risk as they do for residential resale properties. The progress draw mortgage is riskier because you may default on your loan and they will need to repossess the home to get their money back. This is a lot harder for them to do as the home may or not be complete. They have more risk because it could take them longer to sell the home and there’s the uncertainty of the value of the home if it isn’t complete.
A completion mortgage will work basically the same as a mortgage that is obtained to purchase a home for resale, but this mortgage is arranged in advance. Some lenders allow you to combine the two loans where you start with the progress draw and then finish with the completion mortgage later on. You also have the option to go with a standard long-term mortgage once the home construction is finished.
Talk to a mortgage broker that understands construction mortgages. You have a lot of options that you can take advantage of. The right broker can help you weight all the options, so you know what you’ll be getting into and how you can put this sort of mortgage to work to meet all of your needs.