The first of our Construction Mortgage Blogs covered the basics of what you would need to know for this complicated mortgage type. In this second part, we will cover three key areas: The budget, the loan, and key take-away points.
1. The Budget
The budget is the most important piece of information that the lender wants to see. It should include “hard” and “soft” costs. There is usually “reserve” money set aside to ensure there is enough money in the anticipated event of over budget costs. The “reserve” money is usually 10%-25% cash flow based on the budget for the project. This is on top of the down payment.
This table denotes common soft and hard costs that should be included in the budget:
2. The Loan
How the loan is Calculated
Lenders will lend up to a maximum amount determined by the guidelines of the individual lender. For example, based on the lender loaning up to 75% of the total cost (with 25% down):
Land purchase price (as is) Total soft and hard costs Total Cost (as complete)
$200,000 $400,000 $600,000 x 75% = $450,000 available to loan
Keep in mind, the lender will also consider the appraised value of the finished product. In this example, the completed appraised value of the home would have to be at least $600,000 to qualify for the amount available to loan. The appraised value is determined before the project begins.
As well, the client will have to come up with the initial $150,000 to be able to finance the total cost of $600,000. A down payment of $150,000 plus the loan amount of $450,000 = the total cost of $600,000.
Construction loans are released in draws (guidelines are based on the lender). NOTE – between Draws, there is an appraisal/progress report that is ordered by the lender. This is at the client’s cost. These reports are usually around $200 per report, depending on the appraiser.
Draw 1 – Foundation Draw The initial draw is usually based on the preliminary fees. Remember from the example in the previous page that the loan amount is $450,000. Foundation Draw – building the foundation Land purchase ($200,000 – down payment of $150,000) = $50,000 Interest Reserve ($30,000 or 9 months’ interest of the loan) = $30,000 Lender Fee (usually 1% plus any broker fees) = $15,000 Legal Fees = $3,000 Total first draw is $95,000 which leaves $355,000 for construction costs.
Draw 2 – Construction begins! Lock Up Draw – Framing is done and doors and windows can be “locked up”. Whatever amount of money was budgeted for the initial framing component of the project.
Draw 3 – Drywall Draw – You get your drywall up. Whatever amount of money was budgeted for the initial framing component of the project.
Draw 4 – Completion Draw: The Lender sends in an Appraiser to do a progress report to verify that the budget has been followed and build is complete. At this point, the lender will contact you to finalize a new mortgage (a “normal” mortgage) that will be based on the appraised value of the home. Once your building project is completed, we will be able to assist you in moving your construction mortgage to a traditional mortgage, utilizing the discounted rates that we have access to.
The lender may also require a project timeline. Typically, the lender allows a timeline of 6 – 12 months, depending on the lender.
3. What you should know?
- Construction loans are usually fully opened and can be repaid at any time.
- Interest is charged only on amounts drawn. There are no “unused funds”
- Once construction is complete and project completion has been verified by the lender, the construction mortgage is “moved over” to a normal mortgage.
- A lender will always take into consideration the marketability of a property. They will look at not only the location based on demographic but also the location based on geography. For instance, a lot that is in a secluded area where no sales of lots have occurred in the last five years and mostly consisting of rock face may not be a property that they are willing to lend on.
- Depending on the lender, you may have a time-frame within which you need to complete construction (typically between 6 and 12 months).
- Although we’ve described 4 draws, the lender can advance additional draws if needed (i.e. there is a time crunch to pay a vendor and you don’t have enough cash to cover the cost. Or there is unexpected expenses that have come up and you have to dip into your contingency fund (usually a 10% reserve determined by the cost to build).
Problems you can Encounter
- You may go over budget and have to dip into the “reserve” fund as needed
- You may have issues with project management not going smoothly. For instance, trades not showing up to do scheduled work.
- Liens can be put on title throughout the construction project timeline which will delay funding for the next draw. Liens will have to be removed before new draws are released.
Delays in construction and depleted funds can wreak create havoc in a project. Make sure you are working with professionals that have experience and know how to troubleshoot when needed
Construction mortgages are complicated. It is in your best interest to have a mortgage professional guide you in the step by step process of a construction mortgage. At Dominion Lending Centres, we have the expertise to show you how to set up your construction mortgage to fit your needs. We make sure that the costs that will cross your path will be taken into account and that you will borrow the required funds to build your dream home. Give us a call to discuss your options in building the house of your dreams!