New Construction Mortgages - How Draw and Completion Mortgages Work
New construction mortgages are very different that that of a resale home.
Traditional mortgages on an already constructed house allows the lender to hold your home as collateral if you default on your payments. These are resale mortgages and are by far the most common type. With new houses under construction, people must remember that the lender who provides the mortgage may not even have a home as collateral for loan security. This is because the home is in the process of being built. If an issue arises with the homeowners’ job for example due to unexpected circumstances, what would happen to the lenders funds tied up in the build? A fair amount would probably be lost or the builder could be stuck with an unfinished custom home. For these reasons, this is why it may be slightly harder to get a mortgage on a new custom build.
However, there are primarily two types of new construction mortgages for a custom home. A draw mortgage (the most common) and a completion mortgage.
Since the majority of custom builds take on average 8 to 12 months from start to finish, a draw mortgage will allow your builder to pay for the construction of your home along the way.
This type of mortgage is arranged before the construction begins and will be under the homeowners name. This is by far the most common type of new construction mortgage’s.
A draw mortgages is first set up between the homeowner, the lender, and the builder. The lender will first approve the homeowner on a specific amount of money to be used for the build based on factors such as net income, job security, and the specifications the builder provides to the lender. Once approved, the lender will typically set up 3 advancements to the builder during the construction to pay for the new home. Generally, the first draw is after the framing and rough in is complete, the second during finishing, and the last will be close to or at the specific possession date. Each draw will require a progress inspection report which tells the lender that there is sufficient progress made and to what amount will be funded. The last advance of money will be released after the final inspection confirms that the home is complete and occupancy is granted.
Benefits of a Draw Mortgage
The greatest benefit of a draw mortgage is that it is the easiest new home mortgage to get. For the builder, it is the most convenient as well. The builder receives funds from the lender along the way to pay for the material and labour as the job progresses. Lastly, as you arrange for a mortgage draw before construction begins, you will have the option to lock in a set interest rate for the entire mortgage.
Negatives of a Draw Mortgage
The main disadvantage of getting a draw mortgage is that you have to start paying the lender as soon as the first advancement is made to the builder. You will start paying for a mortgage when you don’t even have a house to live in. However, a draw mortgage is still the most common method of new construction lending.
A completion mortgage is similar to that of a traditional mortgage. After the home is completely built, you will be given the mortgage at the time of possession.
However, this type of new home lending is by far the most difficult to come by. This is because the builder has to use their own money to purchase materials for the house and pay the workers for the entire build. All of the risk is on the builder, as circumstances can change over time and potentially leave the contractor with a custom build to now sell to the public.
Benefits of a Completion Mortgage
The greatest benefit of a completion mortgage is that you won’t have to make payments on the mortgage until the home is built. You can live in your current house until your new custom home is complete, and will only have to hold one mortgage at a time.
Negatives of a Completion Mortgage
The main drawback to a completion mortgage is that your financial lending situation can change with time. At the time you sign the purchase agreement of your home until the moment you take possession, your lender may change his terms of mortgage or reject the funding all together. This can create all sorts of problems for you and your builder after a finished custom home is complete.
Lastly, your builder will have to front all of the capital for the new construction. This places great risk on the contractor who is building your custom home as the homeowner may lose funding at any given time. Your builder might end up with a specifically tailored home for one client to now sell to the public. For all these reasons, a completion mortgage is rare to come by.
How to Get a Mortgage
Dependent on the type of lender you use (traditional banks, credit unions, or private lenders), you will need to provide different documents to them when applying for a construction mortgage. These will include a confirmation from your employer stating that you are working, a proof of a downpayment, and a contract that is completely drawn up and signed by your builder of choice.
Once these documents are provided, your lender will most likely apprise the custom home based on the contract between you and your builder and specifications provided of the build. Furthermore, a budget may be asked for from your contractor to give an estimated value of the home. Once this is all complete, your lender will create a term of mortgage and the custom home building can begin.
After a term of mortgage is complete, there will be other factors to consider before a moving into your finished custom home. For example, you will need to get new home insurance ready and arrange for utility providers to supply water and power to the house. There are many other steps to complete along the way, but with a properly chosen contractor, designing a custom home suited for your families needs can be one of the best investments in an individuals life.