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Since building a home from the ground up isn’t the same as purchasing an already-built home, the process for borrowing the money isn’t the same either. For a traditional home, you would get a mortgage. When you’re building a new home, you will get a construction mortgage.
It can also be referred to as a building loan or a construction loan. However, the construction mortgage process is much different than a conventional mortgage process.
How To Get A Loan To Build A Home
Getting a homebuilder loan can be a bit more difficult than getting a traditional mortgage of an existing home on an existing property. This is because the lender is going to require much more information for approval, and you are meeting the eligibility criteria.
With a traditional mortgage, you need to show that you can afford the mortgage and have a good credit score and a low debt-to-income ratio. You need the same for a builder's mortgage and more.
With a builder's mortgage, the lender often requires a much larger down payment. Usually, at least a minimum down payment of 25%. They also require drawings of your build, information on your contractors and step-by-step updates throughout the build process. Depending on your lender, you could either get a draw mortgage or a completion mortgage.
Requirements For Approval
Before you even approach your lender about the loan, it’s important that you already have a plan in place. You’re going to need detailed plans of the construction phase, a budget and a timeline. The lender then uses this information to make a decision regarding the loan.
Lenders require you to prove that you can afford the mortgage as well. Proof of income and employment verification will be required. They need to verify you can pay interest payments during the project and the final payments once the project is done. As long as you can prove all of this, they will approve the loan and issue the required percentages when necessary.
How A Construction Mortgage Works
How construction mortgages work is based on the type of construction mortgage that you get. In Canada, there are two types of construction mortgages you can get for the construction process: draw mortgages and completion mortgages. The lender will decide which type of mortgage to approve you for based on your situation and what type of mortgages they offer.
Draw Mortgages
With draw mortgages, you’re actively involved in the building process. The funds are dispersed as the construction milestones occur, and you don’t receive the full amount until the house is completed. With this type of mortgage, the bank and you are in constant communication to ensure the new build goes smoothly.
Completion Mortgages
Completion mortgages are much different. With completion mortgages, you pay nothing until the home is complete. This is more of a hands-off approach as the homeowner; however, the full mortgage payments are due once the home is completed. At the same time, this is actually cheaper in the long run. Essentially, you’re purchasing the home once it’s been built.
Rates on Builders Mortgages
When it comes to builders' mortgages, it may not come as a surprise to learn that interest rates are higher than they are on traditional mortgages. This is because there’s no physical home that works as collateral if the borrower defaults, meaning that the lender takes on more risk.
This is also a reason why many lenders prefer a draw mortgage, so they can be more involved in the process and ensure their funds are protected.
What Construction Mortgages Cover
When it comes to construction mortgages, it’s important to note that they only cover the costs of the land, building materials and labour costs. All other expenses will be up to you. While a new build is usually cheaper than an already constructed home, it can still be quite costly, and a lot of money is still required to be given upfront.
Pros and Cons of Draw Mortgages
As we’ve already mentioned, draw mortgages, also referred to as progress draw mortgages, are the most common type of construction mortgage. These loans typically last for a year to 18 months. Let’s take a look at the positives and negatives of this type.
Pros
One of the best things about a construction mortgage is that you can choose how your home is built. Customization is the number one reason that people choose to build their own homes. They can even choose their own builders and have control over their new house.
During the building phase, a lender only requires you to make the interest payments, which means your mortgage costs are going to be lower during this stage.
Many lenders will want the first installment of the construction loan amount to cover any remaining mortgage cost on the land, which will combine all of your payments. Plus, once the home is completed, the loan can be rolled into a traditional mortgage.
Cons
While there are many positives included with a draw mortgage, there are some cons as well. The first is that construction loan interest rates are typically higher than those of conventional mortgages. Also, the borrower is responsible for all inspection costs throughout the process.
The lender, such as banks or credit unions, can delay the disbursement of funds, too, if they aren’t happy with the build progress.
Unfortunately, with draw mortgages, if your builder happens to go over budget, you can’t change how much your approval is for, and you won’t receive more funds. This means that any remaining costs have to come out of your pocket. Plus, as the money is dispersed, your monthly payments of interest-only payments will increase until the full amount is given.
Pros and Cons of Completion Mortgages
Completion mortgages are much different from draw mortgages. That said, there are some great things about them. However, they can be risky as well.
Pros
With completion mortgages, you don’t have to start paying the mortgage until the build is completed when the mortgage is given in one lump sum. This is ideal because it can take up to a year to build a home.
Often, you may have to live somewhere else during this time, so you don’t have to pay for two separate mortgages. You also don’t have to confirm funds every time a new stage of the build occurs. Essentially, you’re purchasing the home once the build is completed.
Cons
Completion mortgages are much more difficult to get. This is because the builder fronts the cost of the build and isn’t reimbursed until it's completed. They take a lot of risk in this situation because a lot can change in a year.
The risky thing with a completion mortgage is how your finances can change in a year. If you can’t afford the agreement you made once the build is completed, then you may not be able to purchase the home. In this case, the builder would have to sell it to recoup their funds.
Phases Of A Draw Mortgage
When it comes to construction draw mortgages, the lender releases funds through various phases of the build. Let’s take a look at some of these key phases.
| Draw Phases | Percentage |
| First Draw | 65-75% of land cost (vacant lot) |
| Second Draw | 45% |
| Third Draw | 70% |
| Fourth Draw | 90% |
| Firth Draw | 100% |
The key stages will be based on the lender but include things like:
- Roof completion
- Interior and exterior work completion
- Driveway installation
- Window and door installation
One phase must be completed before you receive the next draw. Once everything is completed, including the draw schedule, a final inspection will give the builder an occupancy permit. The total mortgage will then be converted to a regular mortgage.
How Home Builder Loans Work in Different Provinces
Where you live in Canada will make a difference on construction loans. This is because every province has their own rules and regulations regarding new construction. Let’s take a look at a few.
BC
In BC, most lenders normally use draw mortgages for new construction loans. These loans are meant to last only one year, the time of the build, before they transition from construction to permanent loans or permanent mortgages.
The exact terms of the mortgage agreement depend on the lender. Some allow just interest payments during the build, while others want full payments. It really depends on your personal finance situation, though.
Alberta
In Alberta, you can get either a draw or completion mortgage, depending on the builder and the lender. EIther way, there usually isn’t a timeline for the build either, but the builder will have to stick to the budget.
Ontario
Just like BC, building mortgages tend to draw mortgages in Ontario. These are considered short-term loans that are converted into traditional mortgages once the construction of the new home is completed.
Should You Build or Purchase From A New Builder
Whether you purchase a new home from a builder or build your own home, you’re still getting a brand-new home. While purchasing from a builder is much simpler from a mortgage perspective, you don’t have nearly as much say in the construction of the home.
When you choose to build the home yourself, you can customize your dream home. When you purchase from a new builder, the general design of the home is already laid out. You might have some say in the finishes, but general construction is usually isn’t customizable.
That said, there are some benefits to either situation. Often, purchasing a home from a builder takes a lot of the stress out of the building process, and you still get a brand-new home. You also don’t have to acquire the land yourself, with is much simpler. However, it’s not for everyone. You should weigh both the pros and cons of your situation before you make a decision.
Final Thoughts
In Canada, there are multiple ways that Canadians are choosing to find a place to live. Instead of purchasing an already-built home, many are purchasing land and choosing to build their own. However, when it comes to this, getting the financing can be more difficult than getting a traditional mortgage.
You must prove that you can afford to purchase the home, as well as show plans for construction and a realistic budget and timeline. From there, the bank will determine your approval. Depending on where you live, you’ll either get financing options of a completion mortgage or a draw mortgage.
Typically, construction draw mortgages are much more common, though. Whichever you get, though, you should be certain that it will benefit your financial situation.
