Needless to say, building your dream home involves a lot more work as opposed to buying a ready-build – it’s more than just drawing floor plans and picking out counter finishes. Buying a piece of land and constructing your own home from scratch also requires you to get a different type of mortgage as well.
Whereas a typical mortgage is a complete loan on an existing property that the borrower pays back in increments, a construction mortgage (or “builder’s” or “self-build” mortgage) covers the cost of the construction of your property.
There are two common types of construction mortgages: completion mortgages and progress-draw mortgages
If you choose to go with a completion mortgage, you’re essentially on the hook for construction costs until the project is finished, which at that point, the funds will be transferred to you. Most lenders who offer these types of mortgages want construction to be finished within 120 days. And unlike progress-draw construction mortgages, you have the ability to make changes to the mortgage amount up to 30 days before you take possession of the home. So, if you realize in the middle of the construction progress that you want extra upgrades or additions, you can request to increase your loan and get access to more funds.
You’ll likely be required to make a down payment with a completion mortgage, though you may have the option to pay it in instalments.
The only downside to a completion mortgage is that, for example, if something were to happen and you could not complete construction, you’ve essentially spent your own money and are no longer eligible for the loan, since the funds are conditional on completion.
If you choose to go with a progress-draw mortgage, you only get access to a certain amount of the total mortgage upon completing defined stages in the home-building process.
These stages are known as “draws”, and as you complete each draw, an inspector is required to ensure the draw is completed up to New Home Warranty (NHW) standards. As the borrower, you are responsible for inspection costs after each draw, and some banks will deduct the costs from the draw amount.
Once the inspection is complete, the draw is advanced and you will get access to more money to work on the next draw. Also, lenders will typically stipulate in the loan agreement that you complete construction within a specified timeframe (i.e. a year). A progress-draw mortgage is beneficial if you need access to the funds throughout the construction process and can’t wait until completion for the loan.
Lenders commonly use the following draw schedule when approving progress-draw mortgages. The first draw is optional as an equity take-out if you already own the land. If you don’t own the land, you can simply use the first draw to assist you with the purchase.
|Draw Stage||Required Progress||% of Total Mortgage Amount You’ll Receive|
|Draw 1||15% complete: Excavation and foundation is completed.||15%|
|Draw 2||40% complete: Roof is finished. The building is weather-protected.||25%|
|Draw 3||65% complete: Plaster, drywall, and exterior wall cladding is completed. Furnace is installed and plumbing/wiring work has started.||25%|
|Draw 4||85% complete: Doors and kitchen cupboards are installed. Bathroom is completed.||20%|
|Draw 5||100% complete: Exterior work is completed and building is ready for occupancy.||15%|
One of the downsides to this type of construction mortgage is that once the loan amount is signed and approved, you cannot change it to accommodate any modifications or upgrades to the home.
While your home is being built, you will pay interest only on the total mortgage amount drawn to date. Once the final draw is complete, you will begin to make mortgage payments on both principal and interest.
Applying for a construction mortgage
When approaching a lender for a construction mortgage, ensure you’ve prepared certain documents to show proof of the project, like blueprints, constructions plans/schedules, builder contracts, deed/proof-of-sale of the lot, and a budget outlining building material and contractor labour costs.
Potential homeowners need to provide their lender with proof that the construction of their home will be completed within a certain timeframe. Some lenders will also want to verify that the contractor or home builder in question is certified and has a history of completing well-built housing projects.
This especially rings true for progress-draw mortgages, in which lenders are risking more by giving you a loan. If you fail to complete the project and you default on the mortgage, the lender will have to repossess the land and try to sell it to someone else with a half-finished property on the lot.
You should also note that these construction mortgages aren’t available in every province/territory. For example, many lenders in Quebec and New Brunswick don’t offer progress-draw mortgages.
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