Can You Get a Mortgage to Build a House?
If you're thinking about building a custom home, one of the first questions you might have is whether or not you can get a mortgage to finance the construction. The answer is yes, but there are a few more moving parts than a traditional mortgage for an existing home.
Key Takeaways
Yes, you can get a mortgage to build a house, this is known as a draw mortgage or construction mortgage.
Construction mortgages are different from traditional mortgages on existing homes.
What is a Draw mortgage?
A draw mortgage/construction loan is a type of mortgage that provides financing for the construction of a new, unbuilt home. Unlike a traditional mortgage where you receive the full amount of the loan at once, a construction loan is typically advanced in stages as the construction progresses.
This means that you only pay interest on the amount of the loan that has been advanced which can help keep your payments affordable during the construction process.
To qualify for a construction loan, you will need to provide detailed plans and specifications for your new home, as well as a budget for the construction costs. These will all come within your purchase contract from the builder. Financing typically requires an appraisal and your down payment in some cases can be as little as 5%.
Differences Between a Completion Mortgage and a Draw Mortgage
Completion Mortgage
Some builders don’t require the mortgage funds in draws or stages. They require a deposit at the time the contract is signed and the rest of the funds when the home is complete. Typically, the builders that accept completion mortgages are large-volume builders that are building homes under $1 million dollars in total value.
Draw Mortgage
A draw mortgage/construction loan, on the other hand, is a type of loan that is typically used to finance the construction of a new custom home. Custom, boutique or smaller builders often require draw mortgages to help fund the construction process. A draw mortgage will typically be advanced over 4 or 5 stages.
Qualifying for a Construction Loan
If you're considering building a custom home, you might be wondering how to get a mortgage to finance the construction. Qualifying for a construction loan is different from a traditional mortgage in that you’re already asking for an “exception” product. The lender needs to know that you can weather the storm through the build and make it between draws. Here are some factors to consider when applying for a construction loan:
Credit
Just like a regular mortgage, your credit is an important factor in qualifying for a construction loan. Lenders will look at your credit history to determine your ability to repay the loan. Generally, a credit score of 600 or higher is required to qualify for a construction loan.
Down Payment
Lenders may require a larger down payment for a construction loan than for a traditional mortgage but in some cases you are able to put as little as 5% down on the total cost of the project. The deposit you give to the builder to hold your offer will go towards your total down payment. Don’t forget, just as with a regular mortgage, your down payment will need to be verified with 90 days history on the funds.
Liquid Assets
The biggest difference between a completion mortgage and a draw mortgage is that with a draw mortgage, your lender will require you to prove that you have additional liquid funds. When it comes to builds, in almost every case there are cost overruns and delays. The lender wants to know that if your flooring budget was off by 10%, you’re still able to manage the bill.
Debt-to-Income Ratio
Your debt-to-income ratio is another important factor in qualifying for a construction loan. This is the ratio of your monthly debt payments to your monthly income. Lenders typically require a debt-to-income ratio of no more than 44%. This shows that you have disposable income after covering the cost of your mortgage as well as any additional debts you may have.
Can I get a Construction Loan for a Self-build?
If you are not using a general contractor or a home builder, you may be considering building your home yourself. This is incredibly difficult in Canada. Lenders want to understand your experience as a builder and want you to prove that you can complete the project on budget and on time. Occasionally, local credit unions will finance self-builds, but the major lenders usually want to see a third-party, fixed-price contract.
Alternatives to Construction loans
If your financial situation or your project type means you’re not eligible for a triple-A construction loan, then you may need to consider some alternative financing options.
Private Construction Mortgages
Private construction mortgages are available for borrowers who have a 35% down payment and are willing to pay higher interest rates. Private construction loans still require the project to “make sense” and the borrower needs to have an exit strategy, but they are easier to qualify for from an income perspective.
Home Equity Loan or Line of Credit
If you already own a home and have built up equity, you may be able to use that equity to finance your new home build. A home equity loan or line of credit allows you to borrow against the equity in your home, giving you access to funds you can use to pay for your new build. Keep in mind that this option will require you to have a significant amount of equity in your home.
Personal Loan
Another option for financing a new home build is to take out a personal loan. Personal loans are typically unsecured, meaning you don't need to put up collateral to secure the loan. However, because they're unsecured, they often come with higher interest rates than secured loans like mortgages. If you have good credit and a stable income, you may be able to qualify for a personal loan large enough to cover a portion of the cost of your new home build.
Savings or Investments
If you've been saving for a while, you may have enough money set aside to cover the cost of your new home without taking out a loan. Alternatively, you may be able to cash out investments or other assets to pay for your new home. While this option may require you to delay your home build until you've saved enough money, it can be a good way to avoid taking on debt and paying interest.
Joint Venture
If you don't have the funds to finance a new home build on your own, you may be able to partner with someone else to share the costs. A joint venture can involve partnering with a family member, friend, or business associate to split the costs of building a new home.
Keep in mind that a joint venture will require you to share ownership of the property and make decisions together, so it's important to choose your partner carefully and have a clear agreement in place.
Can I Get a Mortgage to Build My House?
It is important to shop around and compare different lenders and mortgage options to find the best fit for your needs. Working with a mortgage broker who can help you navigate the process and find the best rates and terms for your specific situation.
Contact Spire Mortgage to learn about financing options for building your dream home.
