Residential Construction Mortgages

Building your dream home? This guide explains construction mortgages step by step, including how draws work and what lenders require.

Residential Construction Mortgage Guide

Building a new home can mean a lot of great things for you and your family, including the opportunity to live in the home of your dreams; to save money compared to buying a pre- built home, and the sense of accomplishment and satisfaction that comes with it. However, financing the construction process can often be difficult and time-consuming. As licensed mortgage brokers, our job is to ease

Here Is A Breakdown Of The New Construction Mortgage Process:

1. First of all, consider there are two parts to construction financing. The "draw term" which is the initial construction phase provides the borrowers (for their builder/contractor/trades/suppliers) with funding during the various stages of their home's construction

2. The "end term" or "completion" mortgage is the second part (normal mortgage) that kicks in once the construction is 100% complete. Part 2 is easy! Getting started and through part 1 without scars can be tough.

Understanding The Draw Formula And How Cash Will Flow

During the draw term, money will be advanced in stages based on the work that has been completed up to the draw date. The mortgage lender will normally allow 4 or 5 draws for the borrower (you), and the draw amounts at each stage are driven by a formula based on the percentage of the project that is complete.

It Is Important To Understand

The borrower does NOT get a dollar-for-dollar match for the money already into the project at any given point in time.

The available draw schedule is NOT negotiable: it is determined in advance by mortgage lending rules as part of the approval process and depends on items like whether the loan is a CMHC-insured construction mortgage (low down payment), who owns the lot, and your down payment.
The borrower must prove arrangements are in place at the outset (mortgage approval time) to make up any cash and timing differences between what money the draw schedule will provide you and what your builder/contractor/trades/suppliers require to start (or continue) working on your project.
Lenders like to see a contingency of 10-15% of the build price.
A worksheet/budget showing projected cash and timing requirements is invaluable to illustrate when the money is coming in and when it is going out, and to whom.

Advances (Sample)

Optional First advance prior to start of construction anywhere from 50% to 75% of the lender value on the vacant land (depending on the lender, credit unions tend to lend 75% for land)
Optional 15% first advance at 15% complete - excavation and foundation complete 40% First advance received at least 40% complete - roof is on, the building is weather protected
65% Second advance received at least 65% complete - plumbing and wiring is started, plaster/drywall is complete, furnace installed, exterior wall cladding complete, etc
85% Third advance received at least 85% complete - kitchen cupboards installed, bathroom completed, doors have been hung, etc.
100% Fourth advance received at 100% completed

Percentage Complete/Getting Paid

When a draw schedule milestone is about to be met - ex. the excavation and foundation is complete - the borrower requests a progress inspection. An inspector/appraiser for the bank visits the site and confirms for the bank the percentage complete using a fairly standard table such as in the example form below (form varies a bit lender-to-lender).

Based on percentage complete, the draw amount is then calculated and disbursed to your lawyer, who then pays your builder on your behalf (less a builder's lien holdback as required by law). Some borrowers get a bit confuse thinking simply that the bank deals directy with the builder. In fact the bank deals with and advises your lawyer only, who then disburses the money with you making up any shortfalls.

Don’t Run Out Of Money

As part of the mortgage approval process, the borrower must prove that no one is going to run out of money between draws. Everyone needs to know how the cash will flow before you even get started. Proving you won't run out of money can be accomplished by documenting that:

Builder agrees to carry the financing between draws using builder's own banking/cash resources
Borrowers have enough extra cash-on-hand (besides down payment) or a line of credit available to buffer between draws and/or to allow for cost overruns
The borrower already owns the lot, so the lot value is recovered from the lender throughout the draw process.
Bank of mom & dad can and are willing to 'backstop' the project.

Types of Builds

The following describes how a borrower might choose to get a new home constructed:

Hire a Residential Home Builder - builder must be a member of an approved New Home Warranty Program and register the property with the program. Builder gets paid by you in stages, and in turn, pays his suppliers and tradespeople.
Hire a General Contractor to coordinate the project - contractor must be a member of an approved New Home Warranty Program and register the property with the program. Contractor, suppliers, and tradespeople may be paid by you directly or indirectly via the contractor.
Self-Build - you act as the general contractor and hire qualified, licensed tradespeople to build the home. If in Alberta, you must purchase New Home Warranty at the outset. You must also be able to demonstrate in advance that you have the time, expertise, and industry contacts to complete the project on time*, on budget, and on spec. You will need to prove you have substantial cash resources necessary to carry the project from draw to draw.
Pre-Built - you simply decide all the above is too much work and decide to buy a prebuilt home from a builder and the builder gets paid only when you get the keys (upon completion). This is just a normal new home purchase mortgage, not a draw construction mortgage as described on this page.

*Lenders will put a time limit on the construction phase so that they can cut their losses if you run out of money.

What Is Required For A Construction Mortgage Approval

Borrowers will need to qualify for a mortgage as it relates to standard income, credit, and equity lender requirements. Further, there are extra steps as they related to the property. Construction must conform to the National Building Code of Canada and any other code of provincial or local jurisdiction. As of Feb 1, 2014, newly built homes must be covered under an approved New Home Warranty Program (NHW).

Draw Mortgage - Residential Home Builder

Signed Purchase Agreement
Offer to Purchase for the lot if land not owned, or Deed (evidence of ownership) if the land is owned
Payment schedule expected (note, this must be reconciled with the payments available from the mortgage lender per draw schedule)
Construction Specs or Plans (floor layout and exterior view) plus specification sheet
New Home Warranty Registration registration number

Draw Mortgage - Contractor/Self-build

For General Contractor builds, signed construction contract including construction cost estimates, completion schedule (by Stage), and payment timing expectations per stage.
For Self Build, a list of detailed cost estimates/quotes from various contractors, compiled into a "Progress Advance Worksheet" showing each stage of construction including timelines, anticipated % complete, and anticipated completion date. (ask for us a template)
Offer to Purchase for the lot if land not owned, or Title (evidence of ownership) if the land is owned
Construction Specs and Plans (floor layout and exterior view) plus specification sheet (ie. cabinet types, hardware, finishing, etc.)
Copy of builder/contractor's risk insurance policy (contractor build)
Applicant resume substantiating construction knowledge, project management expertise, and industry contacts (self-build)
Copy of 'Course of Construction' insurance coverage, which covers work in progress until completion.
Copy of your building and development permit(s).