Financing the construction of a new home is different from financing the purchase of an existing home and can be a more rigorous process for the client.
Lenders need more information and often ask for a larger down payment. That said, there are a few options available to clients who build their own homes, giving them the opportunity to choose the option that best fits their financial needs.
Funding differs by country
The process of financing a new home in Canada is very similar to that of the United States. Disparities exist in financial terms from one country to another, and the terms and conditions of loan conversion differ somewhat, but overall, the process of financing a home in both countries follows same general principles.
In Canada, clients can choose to finance the construction of their home through a graduated mortgage loan, a mortgage at completion, or a combination of both. With a mortgage with progressive advances, clients ask for a loan that covers the entire construction process. Amounts are paid at different stages of construction, and each of these steps must pass the inspection before the next payment is granted.
A mortgage at completion requires a signed contract and sometimes a small down payment, but this type of loan must be repaid in full once the house is completed. It is common for a client to first purchase a progressive loan and convert it into a mortgage upon completion of construction.
Similarly, in the United States, construction itself is financed by what is known as a Construction mortgage loan or a construction loan. These loans are usually short-term (normally covering up to 12 months of construction) and often have a higher interest rate than a regular mortgage. Customers generally only pay interest during construction.
A construction loan can be used for the duration of the process and eventually converted to a long-term mortgage, but the client can also choose to combine a construction loan and a long-term mortgage in a single product called “Construction to permanent loans“, which automatically transforms the loan into a mortgage once the work is completed.
You can look at it this way: the progressive loan and the Construction mortgage loan are two ways to name the same type of loan, as is the mortgage on completion and the long-term loan.
How to get a loan
In the early planning stages of building your home , it may be helpful to consult with a lender about financing: you will have a better idea of what is a realistic budget for your home. You could also determine if you qualify for a loan or even receive a loan pre-authorization. Your land (if you have one) or your other property may be used as equity. The most important piece of information that lenders will check is your ability to repay the loan.
Once you have established your building drawings, your schedule and your approximate costs with your builder, you can apply for a loan. Very often, credit unions and regional banks are more likely to give you a construction loan, and some large construction companies may also offer financing. The loan application process is rigorous, and lenders typically ask for an income statement, your credit history, and a list of your assets. By reviewing your financial information, lenders can determine if you are an attractive customer.
If the lender, having verified your information, considers that you meet his criteria, he will need the final plans of your house, the contract signed between you and your builder and, often, an expertise of the expected value of your new home before you can authorize the mortgage with progressive advances or the construction loan.
Even if the construction loan has been approved, neither the client nor the builder will have access to the lump sum. The Progress Advance Mortgage and Construction mortgage loan are paid in installments to cover expenses and accompanied by inspections during construction. These inspections serve to confirm that the project is on schedule and can increase the efficiency of the work on the site. The step for which the previous payment was intended must be completed before the next payment is authorized.
Once construction is complete, if you have chosen a short-term construction loan, there are only three steps left before your loan can be converted into a long-term mortgage: pass the final inspection, obtain a certificate of occupancy and receive signed confirmation that the builders or contractors have been paid in full. Once the lender has received confirmation that these three steps have been completed, the construction loan can be converted into a fixed-rate long-term mortgage, to which all unused funds will contribute.
Some things to remember
It is preferable to obtain a loan with a single closing cost, usually in the form of a construction loan convertible into a mortgage.The builder can sometimes contract the loan for construction instead of the customer, which can be a
factor in the choice of the builder.
The contract may contain certain arrangements for the builder to assume responsibility for payments if construction is delayed. This scenario can help ensure that construction is completed on time and, given the frequency of delays in construction, represent significant savings.
While financing the construction of a home may be more complex than obtaining a mortgage for an existing home, knowing each step of the process and being prepared will help you finance the house of your dreams.