building a home? here’s what you need to know about construction mortgages.
For some people, building a home and learning about construction mortgages makes sense. There’s just something really comforting about being able to live in a home that was built to your exact tastes and that will suit your family’s needs for years to come.
Once you’ve decided to build a home from the ground up, you’ll face a very important decision. Should you buy land and build right away or buy land to build on in the future? Let’s talk about it.
Land first build
Purchasing your land in advance is great if you aren’t in a rush to build. It will give you the chance to pay down the mortgage on the land and build up equity that you can then use to build your house.
To purchase an empty piece of land you will need the following:
- 20% down payment
- An appraisal of the land
When it’s time to build, you will need to put 20% down on the project. The good news with paying down your land mortgage is you can use available equity towards the full project’s down payment.
Building right away
You can complete a build (subject to qualification) with 5% down through the Canada Mortgage and Housing Corporation (CMHC), however, your land still must be purchased with a 20% down payment. Once the land and build have been approved as a total value through CMHC, the down payment on the land will then be taken into consideration for the entire project.
What does the construction mortgage process look like?
- First, you’ll need to meet with your lender to obtain a pre-approval. We will confirm your personal debt servicing ratio to see how much you can afford.
- Once you are pre-approved, you can meet with a builder to determine what you would like your home to look like (aka the fun part!), as well as to obtain any necessary quotes for the foundation, plumbing, and electrical.
- Once the plans and builder’s contract is complete, your lender is required to review them. The building plans and the value of the land will be sent to be appraised as well. The mortgage amount is dependent on the appraised value.
- Once approved, construction can start. As your house is being built, an appraiser will come out as each stage is completed to confirm the process and provide us with a report. As we get the reports, we will advance the funds to your lawyer to pay the builder and the contractors for the work. (More on that below).
Construction mortgages – down payment is under 20%
If your down payment is under 20%, it will need to be insured by the Canada Mortgage and Housing Corporation (or CMHC). You have two options to choose from:
This CMHC premium is slightly higher as it includes four appraisals / inspections. CMHC will use their own appraiser and will send them out to do the inspection to determine the percentage of the project completed.
In this scenario, the CMHC premium is lower. Your lender will order the appraisal for the progress advance inspections. The cost of the progress advance inspections is the responsibility of you, the member, and then funds are advanced based on the percentage of the project completed.
What does the lawyer do?
Keep in mind that all advances will be required to go through a lawyer as they ensure that the proper builder holdbacks are in place and builder liens are registered.
What’s a builder holdback?
These are inserted into a contract as a way to protect the buyer, by ‘holding back’ a portion of the invoice until the work is complete, which allows the parties to complete the work on schedule.
What’s a builder lien?
A simple way for a contractor to protect themselves when dealing with non-paying clients.
Construction mortgages – down payment is 20% or more
If your down payment is 20% or more, the cost of inspections (or progress appraisals) is the responsibility of you, the member. Additionally, your lawyer is required to advance the funds to the builder and they will also look after builder holdbacks and liens.
How are funds advanced?
As mentioned, funds are disbursed based on the percentage of the project completed, as per the appraisal (or inspection report).
Typically, there are five draws.
- Land purchase
- Completed basement / foundation
- Completed framing, roofing, rough plumbing, and rough electrical.
- Completed insulation, installation of doors, windows, sub-floor, and heating equipment, finished drywall, interior brickwork, and cement flooring in the basement.
- Home complete (yay!)
How is the construction mortgage set up?
At the time of approval, you will have two options.
Variable open mortgage
You can choose to leave your mortgage as a variable open mortgage. With this option, you will only be required to make interest-only payments on the funds that have been advanced. Once the construction is at 120 days before completion, you can meet with your lender to discuss fixed rates.
Your second option is to choose a fixed term from the start. This is beneficial when rates are low and you can lock in right away. The difference from option one is that you start making your full mortgage payments right away, regardless of what has been advanced. By doing this, you will end up having more principle at the start and will give you peace of mind knowing what your payments will be.
Ready to get started on your construction mortgage? Here are some last-minute things to think about
- Fire insurance must be in effect once construction is complete, with Sunova listed as the first loss payable. A copy of your insurance will be retained in our files.
- Ensure you have savings set up for any cost overruns that may occur.
- You’ll also want savings set aside if there are any shortfalls in what we can advance (based on the appraisal percentage completed) and what the builder is requesting. Your lender can do up a preliminary worksheet, based on what the builder is requesting as outlined in the contract. This will help see if there will be enough to fund each draw (see above) and to see in advance if there will be any shortfalls.
- You can book an appointment online to get the process started on building your dream home. Convenient, eh?