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 prebuilt 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 remove stress and make it easier for you to realize your dreams.
On this page, we are going to break down the new construction mortgage process to make it easier to understand.
First of all, consider there are two parts to construction financing.
- The "draw term," which is the initial construction phase providing the borrowers (for their builder/contractor/trades/suppliers) with funding during the various stages of their home’s construction.
- The "end term" or "completion" mortgage is the second part (normal mortgage) that kicks in once the construction is 100% completed.
Part 2 is easy. Getting started and through part 1 without scars can be tough.
Understanding the Draw Formula and How the Cash will Flow
During the draw term, money will be advanced in stages based on the work that has been completed 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:
- You (the borrower) do NOT get money in advance to pay for things, like the lot or supplies. (However, it is possible to get a separate loan to buy the lot - ask us)
- 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 things like whether the loan is a CMHC-insured construction mortgage (low down payment), who owns the lot, and your down payment. (See 'Advances' table as example)
- 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.
- 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. Ask us if you need a template.
Percentage Complete / Getting Paid
When a draw schedule milestone is about to be met - say the Excavation and Foundation are 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 hold back as required by law). Some borrowers get a bit confused thinking simply that the bank deals directly with the builder. In fact, the bank deals with and advises your laywer only, who then disburses the money with you making up any shortfalls.
The maximum advance or draw at any stage is typically calculated as follows:
Draw Amount$ = Percentage complete TIMES the total project cost* MINUS your down payment MINUS advances already made.
The calculation and money available is formula driven and not related to the actual cost to get to that stage (so don't go over budget!)
For example: if the total project cost is $500K and your required down payment is $100K, then $400K is the max loan. At 40% complete times $500K project cost yields $200K that should be available to the builder. And it is, being your required $100K down payment and a 40% "first advance" per the formula of $100K from the lender. Note, your down payment money always goes in before the bank's! At 65% complete, the math is 0.65 X $500K less your $100K down payment (already made), less lender's $100K initial payment (already made), yields a further $125K draw available.
It is important to fully understand the timing and amount of the draws before you get too excited about building, as failure to do so will lead to a world of grief and pain for everyone. The point is worth repeating: a lender will NOT give you money for the lot nor work yet to be completed! Someone has to pay for the lot, then keep the builder, suppliers and tradespeople happy between draws. That 'someone' is either you or the builder, or the tradespeople have to agree to work now and be paid later. If you don't have enough money to start or you run out of money before the next draw (hence the trades won't work) or the draw amount is not enough, the project grinds to a halt.
* when you own the lot, the total project cost excludes land. When you are relying on builder to supply lot, then total project cost includes land.
Table: sample progress inspection form for calculating percent complete for a site-built home
Don't Run Out of Money!
So, 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:
- You already own the lot (land title already in your name) or the builder will supply the lot and transfer title to you at first draw, regardless of whether builder has been fully paid for lot or not.
- 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
- 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.
- Rule of thumb: For you to acquire land and build, you need about 1/3rd the total project cost (including land) of your own money. Ex. $600K all-in project likely needs $200K of cash/equity to make it happen.
Types of Builds
The following describe 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 You Will Need for a Construction Mortgage Approval
Borrowers will need to qualify for a mortgage as it relates to standard income, credit and down payment requirements. Further, there are extra steps as they related to the property.
New Home Construction Pre-Conditions
- Construction must conform to the National Building Code of Canada and any other code of provincial or local jurisdiction. In case of conflict, the more stringent code requirement shall apply.
- All homes built after Feb 1, 2014 must be covered under an approved New Home Warranty program (NHW).
Draw Mortgage - Residential Home Builder
- Signed Purchase Agreement
- Offer to Purchase for lot if land not owned, or Deed (evidence of ownership) if 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, list of detailed cost estimates/quotes from various contractors, compiled into a ""Progress Advance Worksheet"" showing each stage of construction including time lines, anticipated % complete, and anticipated completion date. (ask for us a template)
- Offer to Purchase for lot if land not owned, or Title (evidence of ownership) if 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).
Pre-built Completion-Only Mortgage
- Signed Purchase Agreement
- Construction Specs or Plans (floor layout and exterior view)
- MLS or specification/feature sheet
- New Home Warranty Registration registration number