Guide To Construction Mortgages In Canada

A construction mortgage, also known as a home builder’s mortgage or construction loan, provides financing when you want to build your home from the ground up rather than buy an existing one.

A construction mortgage can be used whether you want to hire a contractor to build you a home or if you want to build the home yourself (though you’ll need to prove to your lender that you’re capable of doing that). A construction mortgage can be used to fund building a primary residence or a vacation home.

There are two main kinds of construction mortgages: a completion mortgage and a progress-draw mortgage.

Completion mortgage: Similar to a conventional mortgage, a completion mortgage is funded when your home is fully built. The terms of a completion mortgage will differ between builders, but typically your mortgage isn’t finalized until 30 days before possession. You will likely need to make a down payment, but unlike a conventional mortgage you could do this in installments. A completion mortgage is generally used when purchasing from a new-home builder.

Progress-draw mortgage: With this mortgage, the lender gives the buyer (or more typically the builder/contractor) funds in installments as the home is being built. As the funds are released in stages, it’s critical to know exactly what percentage of the money will be released and after what milestone. The buyer may or may not already own the land.

With a conventional mortgage, you receive the funds for the purchase of your home up front. So if you’re buying a $500,000 home with a $25,000 down payment, you’ll receive a lump sum of $494,000 ($475,000 mortgage + $19,000 CMHC insurance).

With a construction mortgage, you’ll receive your funds in stages called draws, according to the progress of the build. An inspector will assess the progress of the build before each draw is paid out. Most lenders will only cover a percentage of the total cost of construction, usually up to 75%; the balance will be paid by you. You’ll also need to make a larger down payment than if you were purchasing an existing home, typically 25% to 30%.

While the specifics vary between lenders, here’s an example of a construction draw schedule:

If you don’t already own the land on which you want to build your house, some lenders will allow you to use the first draw toward buying land; however, you’ll need to cover between 25% and 35% of the land costs. Or, if you already hold a loan on the property where you’re building, your lender may allow you to use the first draw to pay off that loan before construction starts.

A construction mortgage is a specific type of loan to assist with short-term financing as you build your home. Construction loans are more complicated than conventional mortgages, however, so it’s important to understand some key features:

Pros

• You get the flexibility to build a custom home to your specifications.
• You only pay interest on the loan during the building phase.
• If you already have a loan on the land where the property is being built, your first draw may be used to pay off that loan before construction starts.
• Once your home is complete, you can roll your construction loan into a conventional mortgage.

Cons

• Construction loan interest rates are typically higher than interest rates for conventional mortgages.
• You’re responsible for inspection costs throughout the build process in order to get the next draw of funds. And if your lender isn’t satisfied with the progress, the funds may be delayed.
• Your loan will cover approximately 75% of the estimated cost of construction.
• If your build goes over budget, you cannot change the terms of your construction mortgage.
• Your interest-only payments will increase over the term of the mortgage as you receive more money from your lender.

While many banks, credit unions and other lenders offer construction mortgages, these products are more complicated than conventional mortgages, so it can take more work to find a lender with terms that suit your needs. A good place to start is with your existing financial institution or with a mortgage broker.

The requirements to be approved for a construction loan are similar to a conventional loan in that you’ll need to provide proof of income, sufficient assets and a low debt-to-income ratio. You’ll also need a good credit score; while the threshold varies by lender, expect to need a score of at least 700, which is higher than the requirement for a conventional mortgage. Keep in mind that the eligibility criteria are stricter than a conventional mortgage due to the size of the project, unknown variables (there is a lot that could go wrong during a build) and risks to the lender.

With a conventional mortgage your lender uses your house as collateral, but as there is no existing asset to use if the borrower defaults on a construction mortgage, you’ll need a larger down payment of at least 25% of the total mortgage amount.

Your lender will also require extensive information about the project itself, including background on the builder, blueprints and/or floor plans, budget, supply lists, lists of subcontractors and a detailed timeline. This is especially important as the lender releases funds as the project progresses. Your lender may also require an appraisal, both before the project starts and the projected value of the home.

Securing a construction mortgage can take a lot of work, in addition to all the effort it takes to manage building a house from the ground up. But if you have the financial standing to make it work, the payoff of a dream home may be worth it.