A construction mortgage is a mortgage that covers the cost of the construction of a home; this differs from other types of mortgages in a number of ways.
There are two types of mortgages that you can get when you are buying a home. The first is known as a completion mortgage, under which the loan isn’t transferred until construction is complete – or at least, until one takes possession of his/her home.
One may still be required to come up with a down payment, although it may be payable in installments. Because payment isn’t made until the construction is complete, one can usually make desired changes to the mortgage up until 30 days before the possession date.
Although a completion mortgage can give one some peace of mind that the mortgage won’t be finalised until one has something in exchange – a bricks and mortar home – there is also the uncertainty that anything could take place between now and then.
If you change jobs or get a new loan, for example, your mortgage approval could be in jeopardy. Depending on the length of time estimated for the completion of your build, you might not want to make that kind of commitment. The good news is that if you want a completion mortgage, you probably won’t have to wait that long; most lenders who do these types of mortgages want the build to be completed within 120 days.
The second type of construction mortgage that you can get is called a draw or a progress-draw mortgage, which allows the builder to draw money throughout the building process. With a progress-draw mortgage, the loan is being dispersed in increments: the first, when the build begins; the second, around 35-40%; the third, around 65-70%; and the last, which is close to or at 100% finished.
The progress-draw option is also available if you’re building your own home and need money throughout the process.
This mortgage is beneficial from a cash flow perspective, as the builder doesn’t have to come up with the money for the build upfront without getting anything in return. An inspection is required throughout the building process to ensure that things are on schedule and done properly, and if the build doesn’t pass inspection then the builder doesn’t get the next payment. While these visits are great for keeping things on track, you’ll have to pay an additional fee each time the appraiser makes an appearance. With the progress-draw mortgage, you may be charged interest from the date you make your first payment, and you aren’t able to change the mortgage once your lender advances the initial payment.
A construction mortgage must be secured by the land in addition to its improvement value, which combines to make up the total value of the project. If the plot of land has little or no mortgage, then the builder is able to receive the first draw of financing at once, known as the initial “foundation” draw.
If you’re building from scratch on your own and need a loan to purchase the land separately, you may need a different type of loan to buy the land – a step that generally doesn’t apply if you’re buying a home through a builder.
When buying land, do your due diligence beforehand to ensure that you will be allowed to build the property that you want on that particular piece of land. Some things to consider: the source of water and wastewater removal on the property; how the land is currently zoned/owned/partitioned; current environmental concerns with the property that might need mitigating; and the availability of utilities and other amenities.
The process of getting a mortgage can be a little trickier compared to more typical mortgages. Some lenders have limitations regarding the length of time necessary for the build and won’t lend you money if you expect the build to go on for longer than their specified date. You may also need an estimate when it comes to construction costs – including the land, if that hasn’t been purchased already.
Completion mortgages aren’t a big deal to lenders, because the loan isn’t finalised until the build is complete, there’s no more risk to them than there would be for any other type of residential resale property.
Progress-draw mortgages however are much riskier. A lender charges you interest on your mortgage, but their real fall-back plan in the event that you default on your loan is to repossess your home and then sell it in order to get their money back. With a progress-draw mortgage, that will be much harder to do effectively since the building may or may not be complete.
Not only is there an increased possibility that it will take longer to sell the home, but the value of the home itself is also uncertain if it’s not completed.
Speaking to a mortgage broker who specialises in construction will clear up any concerns you may have, and help you explore all of the options available to you based on your goals. This way, you’ll avoid getting invested in building your dream home, only to have your heart broken when you can’t pay for it.