Construction Draw Mortgage
Navigating the Construction Draw Mortgage Process: A Step-by-Step Guide
Are you looking to build your dream home? If you are planning on building your home through a builder who is covering the costs of the construction until the project is complete, then you will most likely only require traditional financing. However, if you are looking to build on a lot that you already own or will be purchasing and hiring a contractor to piece out the work, then a construction draw mortgage is most likely what you are looking for.
Building a dream home is an exciting venture, but financing the construction can be a complex process. For those embarking on this journey in Canada, a construction draw mortgage presents a structured financial solution that aligns with the progress of your new home’s construction. Let’s dive into what a construction draw mortgage is and how it works.
Understanding Construction Draw Mortgages
Unlike traditional mortgages where you receive the entire loan and pay the builder or seller upfront, a construction draw mortgage disburses funds in stages or “draws” as construction milestones are achieved. This unique feature allows for better management of finances and mitigates risk to the lender throughout the construction process.
The Process Unfolded
Preparation: Prior to paying for permits, blueprints, and other costs associated with beginning the construction for your new home, it is highly recommended to consult with a Mortgage Broker/Agent to confirm you qualify for the construction draw mortgage AND the refinance our after the home is complete. This will not be a full application as you will still need to provide the blueprints and be approved for the permits, however this will provide you with peace of mind knowing that you have the initial financing and exit strategy in place.
Plans and Permits and Quotes: Once you are confident that you have a financial plan in place and understand the process, you can begin to work on your permits and plans. These will take some time have an associated cost, however once done you can submit a full application along with the documents for an official approval. Get quotes from reputable contractors for each aspect of the construction process, including materials, labor, and permits. These estimates will need to be inputed into a cost estimator (feel free to ask us for one) to present to the lender.
Application: To qualify for a construction draw mortgage, you’ll need to meet certain criteria. Lenders typically require a detailed construction plan, including blueprints, cost estimates, permits, and timelines. They will also assess your creditworthiness and income stability. Additionally, you’ll need to confirm a to secure the loan, typically 25-35% of the value of the home once completed.
Appraisal: The construction draw mortgage will require multiple appraisals throughout the process. Keep in mind that these are additional out of pocket fees that you will need to cover along the way. The first appraisal completed is to determine the “as if complete” value and the value of the raw land (without structures). Generally lenders will lend up to 75% of this value. Keeping the loan to value under 65% will give you more options and flexibility. Once the appraisal has been satisfied by the lender, you can begin the project.
Disbursement in Stages: Upon approval, the lender establishes a draw schedule based on construction milestones. Funds are released at key stages of completion and each phase is allotted percentage of the total mortgage. The initial draw is usually 65% of the raw land value plus any other milestones you have already reached.
Verification and Inspections: Each disbursement will incur a fee from the lender for processing and a fee from the appraiser for confirming the progress. There will also be fees for inspectors to complete the necessary code inspections. The processing fees and requirements will all be outlined in the initial commitment along with the draw schedule.
Interest Payments: During construction, you typically pay interest only on the drawn amount. Some lenders will hold off on collecting payments directly from you and instead take them off of the next advance.
Begin Transition to Traditional Mortgage: A construction draw mortgage ideally only acts as a temporary solution. Once you are nearing 97% completion, it is recommended to begin working on a tradition mortgage. With a traditional mortgage, you will have a lower interest rate, ongoing payments and can take out up to 80% of the completed value of your home provided you qualify.
Closing Procedures and Final Inspections: Once your project has finalized, you will be required to complete final inspection to ensure the construction meets specified standards and local building codes.
Convert To Traditional Mortgage: Congratulations! You have successfully completed the new construction draw mortgage process and can move forward with a traditional mortgage.
- Funds Required: An initial down payment (usually around 25-35% of the as if complete value) is often required before disbursements commence. If you own the lot already, this can be considered equity towards your down payment. Please also have at least 10% saved for additional costs that may come up during the process.
- Interest Rates: Rates for construction draw mortgages are higher than a traditional mortgage due to the increased risk during the construction phase. Additional fees and flexibility should be your main focus.
- Payment to Contractors: Payments are generally quick and on time when requested. Keep an open conversation with your Broker and Contractors to ensure you are all on the same page.
- Holdback (Construction Act): There is a 10% hold back of each payment that is held in lawyers trust until project is completed. This will be held for 60 days after the final advance has been completed.
- Fees: The initial draw will be reduced by any fees in your agreement. The setup fee could be between 3-5% of the amount borrowed. There will also be a fee for each draw, appraisal, and inspection required.
A construction draw mortgage can be a great solution to help you fund building your dream home. It should be a temporary solution until you are at least 97% complete. Once you are completed, you will want to refinance into a traditional mortgage.
Please be sure to work with an experience Mortgage Professional who has experience with construction draw mortgages. We have done many and understand the process along with the challenges that can arise. If you have any further questions, please reach out.