So you’re looking to build a new home for you and your family? Or build a home as an investment property? If so, it’s important to be knowledgable of your financing options for construction.
Construction mortgages work on a progress advance basis. The approved loan amount to complete the construction is released to you in various stages, known as “draws” as the project reaches various levels of completion. If you currently own a property and plan to build on it, the funds would be issued in three stages; lock up, drywall and completion. If you do not own the property, and must aquire the land prior to building, the bank would provide an initial land draw to purchase it.
Once you are ready to build you must use your own funds to reach stage one (lock -up). The bank will only release the first draw upon confirmation from an appraiser that the project has reached lock-up. This often comes as a surprise to borrowers, as they feel annoyed they must use their own funds and complete work before receiving funds back from their loan. Unfortunitely banks can only lend on a value where work has reached a certain stage. They’re constantly looking at every mortgage from a worst case scenario; what if the borrower stops paying. They must then take action to recover their funds – typically through foreclosure. A partially complete project can be very difficult to liquidate, and the banks do not want to get involved and have to finish a project. For this very reason they’re very particular about not advancing funds until the work is complete.
Some key points you must know before entering into a construction project:
- To acquire the land or property, banks will typically lend 65% of the purchase price (75% in some cases).
- On the overall project, the bank will then lend you up to 80% of the appraised value as if complete (based on your plan and budget/cost estimates from your builder).
- The total amount of project financing, less the amount loaned to acquire the land, is then issued to the borrower in stages, referred to as “draws”.
- First Draw (Lock Up) – around 40% complete, windows and doors installed and house can be “locked up”.
- Second Draw (Drywall) – around 75% complete, drywall installed and ready to paint, heating system installed and ready for final installation of plumbing and electrical.
- Final Draw (Completion) – house is finished and ready to move in, occupancy permits have been issued.
To summarize, building a home requires a significant amount of capital up front. You must have 25$ – 35% for down payment to acquire the land, and at least 50% of the total construction budget available to get things started.
Please contact me if you have any further questions, or are looking to start the construction process.
All the best,