New Construction Mortgages
A new construction mortgage is specifically for those who want to build their own homes. It’s designed to help a person finance the building process while protecting the lender – usually a bank – at the same time. The lender requires additional protection whenever construction is involved, as there is no guarantee the work will be finished.
In a traditional mortgage, the borrower applies for financing, the lender grants their approval and gives the borrower a lump sum in order to pay for their house. Instead of receiving a lump sum, those applying for a new construction mortgage receive their loans in stages. This allows them to pay for supplies as needed while also preventing the lender from losing all of their money if the project fails at start-up.
The lender releases the funds in three to four stages (also known as “draws). The amount of draws changes depending on if the borrower owns the land they want to build on. If they don’t own the property, an initial land draw occurs, where the lender finances between 65% and 75% of the property’s cost.
The second draw (or first draw, for those that own their own property) occurs on “lock up”. This means that the windows and doors of the building are finished and it can be “locked up”. An appraiser will need to verify that the house is 50% complete. Note that the borrower will not receive any financial aid until this stage is complete – they’re expected to get to this point with their own money.
The third draw occurs when the building has functional heat and drywall and is considered to be 75% complete. The final stage of funding occurs when the building is ready to be lived in, with both plumbing and electricity working.
The Down Payment
A new construction mortgage requires a more substantial down payment than a traditional mortgage. The borrower’s down payment needs to be large enough to cover the cost of the property (if necessary) and reach the first draw. If funds run out before the project reaches the 50% completion mark, the lender will refuse to finance the new construction mortgage and the builder will be out of luck. If money runs out at any other time during the process, the lender has the right to foreclose on the project.
The best way to obtain a new construction mortgage in Canada is to contact an experienced mortgage planner to explain the process. Those looking to obtain a new construction mortgage are expected to provide a budget, a blue print, a construction contract that lists the builder (the lender will need to verify that the builder has the ability to complete the project), a time-line, a down payment and a verification of income.
After the mortgage has been approved, the borrower is responsible for the construction of their project. Building a home is a lengthy and expensive project, but a new construction mortgage can help the process along.