What Is a Draw Mortgage?
If you're considering building a new custom home, you may have heard of a draw mortgage, also known as a construction mortgage or builder mortgage. This type of mortgage is for people building a new home or doing renovations that need the funds provided in installments (not just at completion of the project).
It works slightly differently from a traditional mortgage, as it’s designed specifically for the construction process. If you’re thinking about building a new house or doing significant renovations, a draw mortgage could be a great place to start.
Key Takeaways
A draw mortgage is a type of construction loan that releases funds to the builder at various stages of the construction process.
To obtain a draw mortgage in Calgary, you will require a “fixed-price” build contract, not a cost-plus build contract.
Benefits of a draw mortgage include only paying interest on the amount of money that has been advanced. Interest is either paid on a monthly basis or deducted from subsequent draws.
Definition of a Draw Mortgage
A draw mortgage is a type of mortgage that is used for financing the construction of a new home or renovation of an existing home. It is a type of loan that allows you to access funds as needed throughout the construction process and not just at the completion of the project.
With a draw mortgage, the lender releases funds to the borrower in stages, or "draws," as the construction progresses.
Benefits of a Draw Mortgage
Flexible Access to Funds
With a draw mortgage, you have the flexibility to access the funds you need at different stages of the construction process.
This means the builder can pay contractors and suppliers as the build progresses, rather than having to pay for everything upfront or at completion.
Interest Rate Certainty
Another benefit of a draw mortgage is that your interest rate is set from the advance of the first draw and most draw mortgages are offered at “best rates.” In comparison to a completion mortgage, this means that you set your interest rate today and you avoid exposure to “rate holds” that may or may not be long enough to make it to completion.
With a completion mortgage, you are “guessing” the estimated completion date of the build and if your build is not completed before the rate hold expires, you are required to requalify and accept today’s interest rates.
Cons of a Draw Mortgage
Trickier for Approval
By its nature, a draw mortgage is an “exception product,” meaning draw mortgages are only offered at certain lenders and the approval process can be a lot of work.
If you are applying for a draw mortgage you have to be prepared to do the legwork with your builder to make sure that you can provide all of the required documents for approval. If you’re thinking about a draw mortgage, you also want to make sure that you have strong credit, income, and down payment.
Gaps Between Draws
When a lender commits to providing a draw mortgage for clients, they set a schedule for advancing the funds. Typically, these stages are:
Foundation stage: After the site is excavated, and the foundation is poured and inspected.
Lock-up stage: The point at which the home's exterior is completed, and the property can be locked up.
Drywall stage: When the interior of the house is framed and the drywall is installed.
Completion stage: When all construction is complete and the home is ready for occupancy.
If your builder requires additional funds to make it to the next stage of completion you can be required to inject your own funds. Lenders are very specific about not advancing funds until these construction milestones are met. Finding additional funds to bridge the gap to make it to the next draw stage can be stressful for clients.
Draw Mortgages vs Completion Mortgages
Draw Mortgages
A draw mortgage, also known as a process draw mortgage, allows you to borrow the full mortgage amount in stages as the construction of your new home progresses. Each time you complete a stage, you can draw down the funds needed for that stage.
Typically, the lender will send an inspector to verify that the work has been completed before releasing the funds. With a draw mortgage, you start paying interest on the loan as soon as the builder draws on it, versus paying interest on the full amount right away, like with a traditional mortgage.
Completion Mortgages
When you think of a mortgage, you’re probably thinking of a completion mortgage. A completion mortgage is a loan that does not require any payments until you take possession of your new home. You’ll pay interest on the full mortgage amount only once the home is complete.
With this type of mortgage, the builder does not receive any funds until the construction is complete. Before the building process begins, you'll need to have your mortgage application verified by a mortgage professional and you will put a “rate hold” in place.
Completion mortgages can be a good option if you're looking to minimize your payments during the construction process. Most high-production builders will require a completion mortgage. They will require a deposit or down payment before construction begins, and then the mortgage will fund the day you get the keys to your new home.
A Note about Self-Builds
Unless you are a New Home Warranty certified home builder with a resume full of experience, a self-build is nearly impossible. Clients come to us wanting to build their own homes all the time, and we always encourage them to obtain a 3rd party contract with an experienced home builder.
Over the years, lenders have become less and less amenable to working with clients on self-build projects. It is nearly impossible to mortgage brokers to help with these builds. If you’re considering a self-build, make sure to reach out to a mortgage broker to ensure that you’ll be able to achieve draw mortgage financing.
How to Apply for a Draw Mortgage
Here are some steps to follow when applying for a draw mortgage:
Find a Broker: Look for a mortgage broker that has experience with mortgages. In Calgary, only select mortgage brokerages specialize in draw mortgages and have access to multiple credit unions.
Gather your documents: You'll need to provide your broker with information such as your letter of employment, pay stubs, and tax returns. Bank and investment statements will be required to verify down payment. Make sure you have all the necessary documents ready before you apply.
Get pre-approved: Before you start looking for a builder, it's a good idea to get pre-approved for a draw mortgage. This will give you an idea of how much you can borrow and what your interest rate will be.
Find a builder: Once you're pre-approved, you can start looking for a builder. Make sure you choose a builder who is experienced and has a good reputation.
Get a construction contract: Before you can apply for a draw mortgage, you'll need to have a construction contract with your builder. This contract should outline the scope of the project, the timeline, and the payment schedule. To obtain a draw mortgage you will have to work with a builder that has a fixed-price contract.
Apply for the mortgage: Once you have a signed, fixed-price construction contract, you can apply for the draw mortgage. Your lender will review your application and may require additional documentation.
Complete the mortgage: your lender will require a full appraisal of the project, 100% of your income documentation, down payment documentation and all of the documents from the builder including building permits and Alberta New Home Warranty documents. Once this is received and accepted, they will send the mortgage documents to your lawyer and you will meet with them to sign.
Start building: Once your documents are signed at the lawyer's office, you can start building your home. Your lender will release funds to your builder at various stages of the construction process.
For the full process, read The Construction Draw Mortgage Roadmap.
Is a Draw Mortgage a Good Idea?
Overall, a draw mortgage can be a good option for those who are looking to build a custom home. Sometimes this is a requirement of the builder, so to obtain the home you want, it’s the only path available.
Remember, a draw mortgage is a type of construction loan, so it's important to understand the terms and conditions of your building contract before you commit to a draw mortgage. The lender and the builder have to be on the same page. Make sure you read the fine print and ask your broker any questions you may have about the process.
Apply today for your construction mortgage and one of the experienced mortgage brokers at Spire Mortgage will guide you through the process.
