Image Credit: Armchairbuilder.com
The following post is by Dara Fahy, a leading mortgage planner with The Mortgage Centre Citywide in Vancouver, British Columbia.
Whether you’re thinking about building a new home for you and your family, or you want to build an investment property, you need to know that new construction mortgages work much differently than a typical residential mortgage.
New construction mortgages are given on a progress advance basis. The full amount that you need to borrow, in order to complete your construction, is given to you in stages – otherwise known as “draws” – as you complete various levels of completion.
If you already own the property you want to build on, the amount you need will be issued in three stages: lock up, drywall and completion. However, if you do not own the property, your lender will often give you a fourth draw first – the “initial land draw” – to help you purchase the land.
When you are ready to start the construction, you have to use your own funds to reach stage one. The bank won’t release the first draw until an appraiser confirms your project has reached the first stage; this often comes as a surprise to borrowers but it is essential for banks.
Banks have to look at every mortgage from a worst-case scenario. What if you, the borrower, stopped making your mortgage payments and defaulted on your loan? It’s up to the bank to then recover their losses. Typically done through a foreclosure, a partially complete project is extremely difficult to liquidate. For this reason, banks don’t advance you funds until each stage of completion has been reached.
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There are a few other things you should know, before starting a new home construction project:
- If you don’t already own the property you want to buy on, a bank will typically lend you 65-75% of the purchase price in the “initial land draw”.
- For the overall project, a bank will lend you 65-75% of the appraised value of your finished home; this is determined by your plan, budget, and cost estimates from your builder.
- This amount is issued in stages, otherwise known as “draws”.
- You’ll reach the first draw (lock up) when the project is about 50% complete; windows and doors are installed and the house can be “locked up”.
- You’ll reach the second draw (drywall) when your new home is about 75% complete; your heating should be installed and the drywall is up and ready to paint.
- The final draw (completion) comes after you install the electrical and plumbing; the house should then be ready for move-in, with occupancy permits issued.
To summarize, building a brand new home is not cheap – you’ll need a 25-35% down payment, just to buy the property, plus whatever amount you have budgeted to get to the first stage of financing. A good mortgage planner will walk you through the new construction mortgage process, ensuring you are qualified and have reviewed all of the steps it will take to get from start to completion.