From speaking to clients and friends I know that there are a number of you who would love to have a custom built home, however had not gone down this path for a few reason. Most people avoid custom built homes due to fear of the unknown, usually that fear is the financing and affordability.
How do I finance a build?
Where does the money come from?
How much do you need?
How much do I qualify for?
Can I carry my current home and a new build at the same time?
These are just some of the questions some of you are thinking of.
This post is overdue and to be completely honest, our personal building process has taken a little longer than we anticipated and I really have had a bit of writers block. Frustration and disappointment was high last month. Quick update before we get into the ways you can finance your custom built home. We had a great end to September. We finally heard back from Niagara Escarpment Commission (NEC) and they have given us a few changes that we need to make to our plans. We have since resubmitted the plans to NEC (the change was to remove a patio and a pool as we were encroaching on land we are not able to build on due to NEC restriction). So, now we wait once again for NEC to give us their blessing. To be honest we have built two other homes and dealing with NEC has made this process so much longer and painful than the other two times. Lesson #1 – no amount of homework will ever prepare you for NEC and Conservation.
While we wait for our permits, Rui and his crew have spent a few days clearing up some of the dead trees on the property. In full Portuguese style, they ended the afternoon by cooking a few chorizo on the charcoal BBQ.
A few cold beers, BBQ chorizo with fresh bread -they are happy campers.
I will let you all know how it goes when we hear back from NEC – fingers, toes and arms crossed 😉 Ok so back to the purpose of this blog post. Financing!
I find it best to explain your custom build financing options are to break it down to three options.
- LOAN TO VALUE: with most banks they will allow you to borrow up to 50%-65% of the purchase price on vacant land or existing equity if you already own the property.
- DRAWS: Your first draw is received upon completion of the mortgage and subsequent draws are based on progress. Your second draw will require that your project is at the fully sealed stage or at least 40% completed; Roof is on, the building is weather protected. In order to give you a second draw past 65% of the existing equity. Your third draw will require that you are at least 65% complete; Plumbing and wiring is started, plaster/drywall is is complete, furnace installed, exterior wall cladding complete, etc. Your fourth draw will require that you are at least 85% complete; Kitchen cupboards installed, bathroom completed, doors have been hung, etc. Final draw will be received once you are 100% fully complete.
- RATES: Normally this is an interest only mortgage, and you can expect a rate of prime plus 1%. Once construction is completed you are able to move into a fixed or variable mortgage.
- QUALIFYING: You must qualify to carry any existing mortgage and future mortgage amount needed while qualifying at benchmark rate currently 5.34% at the time of this blog post or mortgage rate plus 2% whichever is higher (thank the stress test for that). So today that means you could be looking at qualifying at 6.70% if your rate is 4.70%. (remember that prime is currently 3.70%)
- COSTS: most banks do not charge a fee for setting up this type of mortgage however you will have to pay for appraisal fees. Note that an appraisal is normally required for every time you require a draw and appraisals range usually about $350+/-
- TIMEFRAME: Maximum 15 Month Construction Period – Construction must be completed within 15 months from the date of the 1st advance
- PROS: you are going to get the best rate available, with usually no fees associated with this product
- CONS: qualifying may be an issue for some. The second draw is normally when the house is completely sealed (getting a home fully sealed is about half of your budget, so you may need to save a little before you start if you want to use a bank). It takes a little longer to get your draws as you are waiting for the branch to set up a time to have the appraiser come out and complete his/her report. Then the branch must process it. So normally it can take more than 1-2 weeks to get your draws – this is time lost and money spent.
- Credit Unions
- LOAN TO VALUE: Very similar to the bank however they are able to offer you a bit more upfront. With vacant land, you are looking at about 50% down payment required. However if you have an existing home they will loan up to 80% of the current value. This often times gives most people who are looking to renovate or rebuild a new home a great start. A great example of this is if you own a home that is currently worth $500,000 and you have $200,000 mortgage on the property. In this case the lender will allow you to borrow up to 80% of the current value. This means that you are able to borrow up to $400,000. If your mortgage is currently at $200,000 this means that you have $200,000 to help you start the process right away. You don’t have to take the entire amount as you will be paying interest on it right away, but you can take enough to pay your architect, permits, plans, etc.
- DRAWS: Very similar to the bank, however the credit union usually gives you the second draw at footings and foundations and doesn’t require that you are fully sealed.
- RATES: Similar to the banks, you will be in an interest only product. Once construction is completed you are able to move into a fixed or variable mortgage.
- QUALIFYING: As of today, there are still banks that will allow you to qualify at the contract rate instead using the stress test and this means that your mortgage power is increased by about 27%
- COSTS: Depending on the credit union there may be a fee of aprox $3,000 (admin fee from the credit union) to set up the mortgage and cover draws, however not the cost of the appraisal. Note that there may be a cost if you want more than 4 draws.
- TIME FRAME: For self-build they will allow for 6 months however if you are hiring a contractor, the lender will follow the contractors building schedule
- PROS: A bit more flexibility than the bank, better qualifying rate
- CONS: Set up fee. It takes a little longer to get your draws as you are waiting for the branch to set up a time to have the appraiser come out and complete his/her report. Then the branch must process it, so normally it can take more than 1-2 weeks to get your draws – this is time lost and money spent. Advance is calculated by multiplying the construction costs by the percentage complete – less the 10% holdback and inspection fee.
- LOAN TO VALUE: With most private lender you will be able to borrow up to 80% of the future value and 50%-65% of the current vacant land. There are not many places that will loan past 65% on vacant land. Here is an example: you purchase a property with a house on it for $350,000, and you plan to eventually tear down that house. The lender will require at least 20% down payment so that means you must have $70,000 as your down payment. The lender will then base you mortgage on the plans for the build. Let’s assume you plan to build a $1M home. This means that you will be able to borrow up to 80% thus an $800,000 mortgage. On day one you have a $280,000 mortgage and you need $500,000 to build your dream home. This means that you will need $780,000. Since this is below 80% of the future value, you will have access to the full amount required.
- DRAWS: Each private lender is different, however most will give you the first draw on closing, and subsequent draws based on the builders construction plan. Usually, footings and foundations, lumber delivery, framing completion, window install, roof install, drywall completion, kitchen and finishes delivery, final finishes, completion.
- RATES: This is by far the most costly rate usually starting at 8.99% interest only
- QUALIFYING: There is no stress test, the lender is basically looking at the reasonability of you making payments and completing this projects. This is the best options for people who are having a hard time qualifying with traditional lenders.
- COSTS: There is normally a 2-4% lender/brokerage fee associated with this type of borrowing.
- TIME FRAME: As with everything private mortgage related, there must be a reasonability to it. So if you are waiting for permits, this is reasonable, if you are in the middle of your project and nothing has happened for 2 months – not so reasonable.
- PROS: There is normally no down time between when you request the next draw and the time you receive it. This is important to note as so many people focus on interest rate, however there are costs associated with anything and in this case the speed in which you receive your money may save you much aggravation with your trades (imagine your roofer was scheduled for next week and you didn’t get your draw in time to pay him, now he took on another job while you are waiting…he must finish that job before he comes back to you, so now you are waiting longer – spending time and money waiting). The biggest pro – is qualifying
- CONS: Cost, there is a higher cost to setting this up.
- ADDITIONAL: Once you are finished with your build, we would have do a takeout mortgage, meaning we would move you to a primary lender with best rates once your construction is complete.
Please keep in mind that the lender (regardless of which you choose) will want to see your plans for the renovation/build and will base the mortgage on future value for the build. The lender will want to see contractors breakdown of costs and timeline for the project.
I know that this looks like a lot of information, however this is just the tip of the iceberg. If you are interested in learning more about construction financing and building or renovating your home, send me a message firstname.lastname@example.org and I would love to help.