Why try to buy your dream home when you can build it for yourself with the help of a Reputable Home Builder, Quality Architect, and Knowledgeable Mortgage Broker? Building your own home is possible with a residential construction mortgage, however there is much to understand before you jump in and get started.
The Building Process
At a high-level, the building process looks like the following:
- Discuss construction plans and financing options with a construction mortgage specialist that is going to be with you every step of the way.
- Hire an architect and builder to draw up plans and permits for the new build
- With the help of a custom builder’s estimates and a mortgage professional’s advice, draw up a realistic budget and timeline for the necessary financing draws
- Oversee the build to completion
- Consider refinancing your equity construction mortgage into a conventional home mortgage with a new (typically lower) interest rate
The Financing Process
From the building process, the financing process can also be broken down into a series of simple steps:
- Hire your contractor, get a copy of the architectural drawings, and plan out the interior and exterior design characteristics of your home
- Give this information to an appraiser who will estimate a value of the completed home
- Using the lesser of your contractor’s construction cost estimates and an appraiser’s valuation, apply for up to 80% of the construction value in a mortgage
- If you are self-employed, provide prospective lenders with bank records and your company’s financial statements for the past two years
- You can apply for equity financing for residential construction if banks or credit unions say NO
- Draw a certain percentage of the funding at each level of completion, which will be pre-determined by your lender
- At the end of the build, receive any outstanding balance and hold backs on the mortgage
- Consult with your mortgage professional and consider the outstanding debt left owing on the construction loan for a conventional mortgage loan for (typically) a lower interest rate
Understanding the Building Costs
Hidden costs are far from being the only costs involved in a residential building project. The first major expense is the physical land upon which the home will be built, which in certain circumstances can be factored into the total mortgage. The rest of the costs can be broken down into hard costs (raw materials and labor), soft costs (engineering, permit and architecture fees), and allowances (flooring, backsplash, décor).
These costs are the most visible, however there are other costs and dollar figures to be aware of. Budgeting a home build is not always perfectly accurate and unforeseen expenses can happen along the way. Preparing for this with a contingency reserve is usually best, as anything not spent can be put into the down payment at the beginning of the mortgage period. Typically, 10% of the initial construction costs should be the amount of your contingency reserve.
Any lot equity, which is the difference in value of the loan on the land and the land’s appraised value, will typically be credited towards the down payment.
For building on rural land there will be engineering cost such as PERC or Drainage Tests and Water Potability Tests. Approvals of a local conservation authority is often required in addition to municipal building permits.
Building vs. Buying a Home
Many homebuyers will choose to build their own home as it allows them to craft their dream home according to their exact desires, while remaining in their specific budget. One downfall to building your own unique home is that if you choose to sell the home in the future, you must keep in mind market standards and general tastes of future homebuyers. Consulting with designers before signing off on the home’s design is the best way to ensure your home will be marketable in the future.
Buying a home is great if you want to avoid the hassle of the building process and hiring contractors, however there can be many other hassles down the line if you are unable to uncover them before purchasing. For instance, some homes may have hidden issues such as asbestos or faulty appliances that will cost you time and money down the line to fix. Building your own home ensures the appliances and home structure are new.
Understanding the Financing Process
The most common mortgage type for self-build homes is the progress draw mortgage, which involves the lender providing certain amounts of the financing at various times during the build process. Financing contracts will stipulate certain percentages of the original loan amount to be paid at various levels of construction completion. Upon completion, the outstanding balance of the mortgage will be paid to the homebuyer and all money left owing will make up the conventional mortgage on the home.
To acquire this type of financing, you need to obtain the proper planning for your build, including hiring a qualified contractor, obtaining the architectural drawings of the home, and details of the exterior and interior design characteristics of the home. These must all be provided to an appraiser, who will provide an estimated value of the home. The contractor will also provide a quote for the construction costs, which will include a draw schedule that should mimic the draw schedule you receive through your progress draw mortgage.
Beware that construction financing is based on the lesser of the market value of the home and the construction costs. If the cost of the build exceeds the home’s estimated market value, you may not be able cover the entire home construction with a mortgage alone and may need upfront cash.
Note that interest rates for construction loans will be higher than traditional mortgages, however the rate will lower once the outstanding construction loan is factored into the home’s conventional mortgage.
Raising the right financing can be difficult, and if done incorrectly, can cause you serious financial hardship. Gerard can assist you in finding the best financing option for your specific situation.
To Download our White Paper on New Home Construction or for further information on Construction Mortgages, visit our services page on New Home Construction.
Gerard Buckley, Mortgage Agent at Mortgage Wellness, has offices is in Collingwood, Owen Sound and Toronto with access to over 80 specialized lenders.
Please Call Gerard at 705-532-1182 for a complementary consultation.