Construction Financing: A Step-by-step Guide
Building your own home is an exciting and rewarding project. We are here to help you understand the process of financing the construction of your new home so that you can get started with confidence and proceed with peace of mind.
You may have some experience in obtaining mortgage financing but as you will see, construction financing is a more detailed process with several important milestones that don’t take place when you buy an already existing home.
We have created this guide to help you plan your project and understand how construction financing works.
What to expect
When you build your own home, there are additional steps and expenses as opposed to buying an existing home. In the simplest terms, a typical mortgage is advanced in one lump sum.
Construction financing is different. The lender typically requires you to pay any costs upfront, and then the total amount borrowed is usually advanced in three stages over the course of the loan usually one year.
Determining what you need to get started
During the application process you will need to understand the initial costs that you will be responsible for:
Land
To secure the construction financing you are required to own the land, as the lender will need to register a mortgage on it.
Servicing
The land you intend to build on needs to be fully serviced. This includes site preparations and municipal services such as septic service, water connection, sewer connection, hydro, and gas service.
Soft Costs
Soft costs are out-of-pocket expenses for services and charges you are likely to incur at the outset of and throughout the construction phases. Depending on your plans and the location of your home, these will likely include:
Plans and Survey Certificate
Municipal Permits
Fees for Architect
Legal fees
Fees for mortgage broker
Insurance
New Home Warranty
Initial Building Costs
You are expected to finance the initial stage of construction (approximately 35% of the construction cost) with your own money.
Cost Overruns
We recommend that you set aside an additional 15% of the estimated construction costs to cover unexpected overruns.
Interest Costs
You are required to make interest only payments on all amounts advanced until your regular principal and interest payments begin. In addition to the costs already outlined, you will also need to budget for lien holdbacks.
Lien Holdbacks
Your solicitor is required to hold back some of the money advanced at the Rough-In, Drywall, and Completed Stages of your construction project. This money is held in reserve in the event that a contractor or supplier claims a lien on your property. A lien is a claim by a contractor against the property to secure payment of unpaid construction costs.
The amount of your lien holdback and the number of days that your funds will be held in trust varies by province. The lender will instruct your solicitor to hold back a percentage based on the province you are building in. In British Columbia the holdback amount is 10%.
(For more detailed information and/or explanation ask your lawyer or solicitor).
The Application
Here’s what you should plan to bring:
All information associated with the construction including:
Construction contract from your builder
Construction plans
Any permits from the city
Cost to Build breakdown from your builder
Copy of your sale agreement or copy of your mortgage statement
New home warranty documents
Photo ID
Other requirements to help fulfill the application for construction financing:
Confirmation of required fund to complete the rough‐in stage (35% of construction costs)
Confirmation of income and employment
Name, address, and phone number of your lawyer or notary
As the lender reviews the details of your building project, they will notify you of what other documentation, if any, will be required to proceed with your application.
The Appraisal
This determines the estimated value of your completed home. The lender will obtain this appraisal to estimate the value of your completed home, including the land.
To arrive at an estimate, your appraiser will review your construction plans to understand the type of home you are building and then compare it to other similar properties in your area.
Your First Advance – The Lock up Stage
When you have completed the lock up stage, the lender will send an appraiser to your home to inspect the property and confirm that the lock up stage is complete.
Up to this point you will have paid all the expenses from your own resources.
The lender will release your first advance of funds to your solicitor, who will keep a percentage of it as a lien holdback (10% in British Columbia). At this point interest only payments will commence.
The amount of your first advance is determined by a formula based on the total requested mortgage amount and the remaining cost to construct your home.
Prior to releasing the first advance, your solicitor will need the following:
Builder’s all-risk insurance assigned to the lender
A site survey showing the location of all buildings to be constructed
Confirmation that all necessary building permits are in place.
Your Second Advance – The Drywall Stage
When you have completed the drywall stage, the lender will send an appraiser to your home to inspect the property.
If everything is approved, the lender will release the second advance to your solicitor and once again the lien holdback will be applied.
The amount of the second advance is dependent on the requested mortgage amount, the amount of the first advance, and the remaining cost to construct your home.
Your Third Advance – The Completed Stage
When you have completed your home, an appraiser will once again inspect your home.
When the appraiser has determined your home is complete, the lender will release the final advance of the funds to your solicitor and the lien holdback will be applied.
Prior to releasing the final advance, your solicitor may request further documentation which may include:
Occupancy Permit
New Home Warranty Certificates
Release of Lien Holdbacks
All lien holdbacks will be released to you approximately 30 – 60 days after your project has been completed, assuming there have been no lien claims made against your property.
Mortgage interest and principal payment
By the time you reach the completed stage, most of your mortgage amount will have been advanced to your solicitor.
You will be required to start making regular mortgage interest and principal payments shortly after receiving your third advance.
We hope this brought you value and explained the construction financing process. For more information contact AVANTUS FINANCIAL INC at 604-787-3573