# How does new construction financing work?



## swoop_ds

If I already have a partially paid off mortgage on a home, and wish to have a new home constructed, how does the financing work? 

Specifically:
1. Given the "flexible" nature of construction budgets, how does the mortgage deal with budgets that go higher or lower than expected?
2. Does the fact that we would still leave in our current home until the new home is built affect anything? (Down payment size)


----------



## marina628

We did this in 2009 and the bank used our 'existing home' and gave us credit line to start the construction phase then as things progressed they gave us advances of $50,000 at a time.We gave ourselves 16 months to build though and finished about 2 months early.You make interest payments on the loan while construction is going on and once it is completed then you get the mortgage fixed.It is really a contract between you , your bank and the contractor and there is lots of paperwork.First thing we did was sort our a budget and how we were paying for it then we had find the builder and get the plans in place with proper quotes .


----------



## birdman

Lots of different ways depending on your net worth, security, employment, etc. It also depends whether or not you own the lot and what the loan to value ratio is. When I was in the business on of the more common ways was to grant the borrower(s) a mortgage to cover the lot purchase and finance the construction costs but register the mortgage "inter-alia" over both properties. Of course you would need a detailed budget and normally a firm contract from a reputable builder. Thereafter, funds would be advance on a "cost to complete" basis which is that the undrawn portion of the loan must be sufficient to complete construction. Sometime a quantity surveyor is also required. Again, there are lots of ways of doing this but the foregoing may give you one approach to consider. Of course, if you own the lot outright it is quite possible to register the mortgage over just the one property.


----------



## donald

When I built and got a construction mortgage(I owned the lot though so maybe it is different,prob)
I had to submit a complete breakdown of all the trades(business names and quotes-they ''rbc'' I am guessing had a general idea what said quotes should be or at least ''ball'' park and than was advised to add 8-10% as a buffer and than was given the loan in that amt and it was fixed-5 yr term
I got 4 draws and expect the last draw a rbc employee came physical out to my property(seemed more like drive by's actually) and confirmed the work that should be done and I do remember they had general timelines ect they expected for each draw.


----------



## leblanc

Hey swoop_ds,

I am mortgage broker and have done new construction financing for my clients in the past.

Before I answer your questions there are few things you need to know:
1. a 'mortgage' is a loan that is secured by real property (the house)
2. a lender who borrows money for mortgages, has no security when it comes to the physical land
3. a construction mortgage is funded in draws, for example 35% complete, 65% complete, and 100% complete (this will vary depending on which lender you use)

Now all that being said, you will have to already have your land secured or be working with a builder who has lots. The lender will not give you money for the land.

here are the answers to your questions:
Question #1 - The 'budget' is finalized prior to building with quotes from a reputable, licensed contractor, sometimes required to carry 'New Home Warranty' - So *always get high quotes to allow for cost overruns*. You will be liable for any "extra" costs and will have to fight with the lender after to recoup this into the mortgage.

Question #2 - You would have to have the down payment for the new mortgage ready. Or arrange for bridge financing.

Your new mortgage would be interest only payments until the construction was complete, at a predetermined rate, and then you would lock into a 5yr fixed rate or variable rate.

It's important to note that you will not see ANY money from the lender until the specified stages of completion. And you will have to come up with any costs from your reserve (or loan), in the meantime. I hope I answered your question.


----------



## swoop_ds

Very helpful everyone thanks a bundle!

Just wondering if the doe payment would need to 25% then if you're still living in the first house?


----------



## marina628

Our plan was to sell our home once we moved to new home so you would transfer the equity from the old home to the new home ,your existing equity has to do with how the bank will structure your deal.This is very much a individual case by case decision so you probably need to see your banker on what you can do.


----------



## birdman

Marina is correct and we can't provide you with exact details without your providing additional information and in particular the approximate value of your current home and the amount owing on your mortgage. Then, one would also need to know the approximate cost of the lot and approximate construction costs. At least this would be a starting point. 
For example, if your existing home was worth $500,000. and you owed say 50,000. is quite different than if you owed $300,000. on your current home. Also, what would you guess the lot and construction costs would be? I would suggest the ABSOLUTE maximum you would ever hope to be able to borrow from a conventional lender on a conventional basis would be 75% of the value of your existing home (less existing mortgage) and 75% of the value of your new home. In saying this, 60 or 65% would probably be more realistic. One mortgage for the cost of the lot and construction would be registered against both properties. This is what an interalia mortgage is and refer to my previous post. Also, there is the matter of debt servicing and do you have sufficient income to carry the construction mortgage and your existing mortgage?. As mentioned by leblanc, a mortgage is simply a document registered in the land titles office securing a "loan". You would have one loan for the construction secured by a mortgage over the new house (it would be a 1st charge on the property) and the security (the mortgage) would also be registered (interalia) against your current home. It would be a 2nd charge against your current home as your current mortgage is the 1st charge. Things can change depending on whether you are going to act as the general contractor, have a fixed price contract, or have hired your contractor on a cost plus basis. Be prepared to pay some fees like appraisals over both properties, legal, interest, bank fees, quantity surveyor fees (if required), etc. If you are buying the lot from a developer sometimes they have arrangements for "builder financing" and then you can buy the property outright when completed. An owner acting as their own contractor is generally frowned upon but again, this would be deependent on the equity in your current home and on the one you are building. Good luck.


----------



## swoop_ds

Okay this information has helped a lot. I think we will talk to a mortgage broker going forward. 

Thanks for all of the well thought out replies!


----------



## nobleea

If you own the lot, can the lot value be considered part of the downpayment?

For example, if you own the lot, valued at $350K and then build a 400K house on it, will the lot value work as a downpayment and get full mortgage for the 400K house?
What about if you had a mortgage on the lot of 50% (so 175K equity) and then built a 400K house. That's still over 20% down. I assume this would work as well?


----------



## leblanc

No it cannot. And there is no such thing as a 'mortgage for land'. Equity is only in the physical property. That wouldn't work at all.

A mortgage is a loan against real property. Where the physical house is the security for the loan.

You may be able to leverage the land to get a loan to build the house, but that would be done through a bank.


----------



## nobleea

leblanc said:


> No it cannot. And there is no such thing as a 'mortgage for land'. Equity is only in the physical property. That wouldn't work at all.
> A mortgage is a loan against real property. Where the physical house is the security for the loan.
> You may be able to leverage the land to get a loan to build the house, but that would be done through a bank.


Sorry, not following you here. Are you saying that if I owned a lot, purchased for $350K, and then had a builder put up a house on it that cost 400K using a construction mortgage for the house, I would have to come up with 80K downpayment on the construction loan? Even though, once the house was finished, the whole thing would be appraised at 750K+?

To add: what if said lot was actually a teardown house? That could be purchased with 20% down, but then in order to tear the house down, the LTV would have to be decreased to 50%. At least that's what friends have done when doing infill.


----------



## birdman

nobleea: yes, if the lot was appraised at 350,000. (it doesn't matter what you paid for it) and you owned it outright you could obtain a mortgage for 400,000. to build a house as the loan to value ratio would be 53%. This is on the assumption that the completed home would have a value to support the loan to value ratio. There would of course be a number of other requirements including job stability, adequate debt servicing, satisfactory credit report, contractor, etc. Also, the money would most likely be advanced on a "cost to complete" basis; in other words, the undrawn portion of the loan would have to be sufficient to complete the house. Again, a quantity surveyor is often used to verify this. Also, contrary to a previous post, you can obtain a mortgage to purchase land. Financial institutions have policies regarding certain types of land. For example:
House: Maximum loan to value 75%
Land (lot) Maximum loan to value of 50%
Recreational property: Maximum loan to value of 50%
Commercial property: Maximum loan to value of 70%
These are just examples and even these are often only guidleines. If you wanted to build a home way out in the boondocks with no water or power they would maybe only lend 50% of the value, or, perhaps nothing at all. Lots of other things come into play.


----------



## donald

Hey frase,I own a property that is on 1 title but it was registered like this by my city municipality @ the turn of the century but it is actually 2 lots,1 across a backlane(future development opportunity)1 lot being buildable and has services nearby ect.
Purchase price was 160k but to hook up the sewer and water and install a ''curb''(small roundabout)will cost another 30k....so all in 190k(for one lot) but,being on one title the backlane lot never had a independent assessment(the city property and planning are still working on splitting it on 2 titles)
How do financial institutions place a value on land?independent statistics or do they take cue's from what the city's property and planning peg as the value?not sure if I am making any sense......my property only ''shows'' up as one thing but it is not.(for leveraging)


----------



## leblanc

Frase. Your wrong. Unless you have extremely high net worth (50% or more LTV), its almost impossible to get a mortgage for bare land (as the lender has no security that this land will ever be developed). And they will not use this as 'equity' for a down payment.

Some banks will allow you to leverage the land to take out a loan, which then that leveraged money can be used for a down payment.


----------



## birdman

Good question Donald and I'm really not sure of the answer. Often it depends on the lender you are talking to and does he or she understand the situation. Also, I am uncertain 
that it would make any difference and remember, financial institutions depend on the appraised value of the property. So, an appraiser would review the current status of the property and provide a valuation. This is what the financial institutions would use but they could also discount it if the appraisal suggested it had full value as 2 lots even though one had not yet been formerly subdivided. Lenders use appraisals to make lending decisions but in complicated situations they considered the actual content contained in the appraisal. Also, I would suspect that if you cut off one lot the value of the remaining one would decrease. If you have a mortgage against the property, the mortgage company will most likely want the mortgage registered over both properties (this may happen automatically ???). I f this happens you would then have to go to your lender and ask them to discharge it over the new lot. Of course, they would want an appraisal over the old lot. Sounds like an interesting project.


----------



## birdman

leblanc: Didn't want to clutter the thread, pm sent.


----------



## carverman

leblanc said:


> Frase. Your wrong. Unless you have extremely high net worth (50% or more LTV), i*ts almost impossible to get a mortgage for bare land (as the lender has no security that this land will ever be developed). And they will not use this as 'equity' for a down payment.*
> 
> Some banks will allow you to leverage the land to take out a loan, which then that leveraged money can be used for a down payment.


From my own experience here in Ontario, owning a building lot for a while , and a house (that still had a mortgage on it), this seemed to be the case for me. 
CIBC (my mortgage holder) indicated that I would have to get an appraisal on my home in Ottawa, (HELOC) and an appraisal on the lot (out in the country) and before I could even think about the next phase. After doing some calculations on what it what it was all going to cost me before the prefab home (Seahawk) could even be installed on the foundation, I decided to put the lot up for sale.


----------



## Four Pillars

leblanc said:


> No it cannot. And there is no such thing as a 'mortgage for land'. Equity is only in the physical property. That wouldn't work at all.
> 
> A mortgage is a loan against real property. Where the physical house is the security for the loan.
> 
> You may be able to leverage the land to get a loan to build the house, but that would be done through a bank.


I'm not following your logic. In a lot (pardon the pun) of cases in bigger cities, the property (ie the land under the house) is worth far more than the physical house and an empty lot is just as liquid as a built up lot. I'm no banker, but I just don't see why they wouldn't accept an empty lot as collateral. 

Sure, as Frase says - there are probably situations where they won't do this - especially in a rural setting where there might not be much if any real value to the land.


----------



## donald

I would think empty land/lots def have value(provided it is a serviceable lot)Maybe this falls under more commercial bank lending or more specialized banking but I know for certain if a home building company buys 6 lots they are def using leverage on it(must)and the bank must know there is also higher margins because lots selling that are raw are at a discount(example)and are priced below actual value.
Thanks frase ,yeah interesting is one way to put it!It's a long story!Was a full blown nightmare not so long ago but the tide change for somewhat.


----------



## marina628

donald said:


> Hey frase,I own a property that is on 1 title but it was registered like this by my city municipality @ the turn of the century but it is actually 2 lots,1 across a backlane(future development opportunity)1 lot being buildable and has services nearby ect.
> Purchase price was 160k but to hook up the sewer and water and install a ''curb''(small roundabout)will cost another 30k....so all in 190k(for one lot) but,being on one title the backlane lot never had a independent assessment(the city property and planning are still working on splitting it on 2 titles)
> How do financial institutions place a value on land?independent statistics or do they take cue's from what the city's property and planning peg as the value?not sure if I am making any sense......my property only ''shows'' up as one thing but it is not.(for leveraging)


Donald my brother in law has same situation and he is hoping to sell his back lot off to a builder soon ,he was told by municipality that he had to get a new survey done and legally split the land from the main parcel to sell it but he is free to build a second home on it anytime .Banks will give you loans that you can use to purchase land but to use land as security is difficult and generally they will charge you higher rates .This was advise we were given back in 2009 when we bought our land and at that time they wanted 7% so we took a credit line against our home for 3% to buy it.


----------



## donald

I hear you marina.In my case the lot is bought and paid for(no financing needed)It just comes with a back lot that is not presently buildable but....(knowing the area like I do and with it being in the city limits)it is prob 10/15 yrs away from development,i wouldn't dare sell it vacant(I peg it around 35k as it is-125'x115'(wider than longer so likely could be split into 2 actually and it is full of white birch tree's and is a perfect backdrop for the lot I am building on(my future hot tub on the back deck will look into this ''small'' forest setting 
There is a methodical method to it......I think I am fine with the leverage from the first value of the primary lot(to secure construction mortgage)I was just more curious on the ''how'' banks evaluate.
I know my last house was priced like 30% lower by my city(for taxes)and the bank had it peg more correctly and higher than that(confirmed by selling it close to what the bank said it was worth,strange because I would of thought cities are just as greedy as banks and want as much taxes as they can get,school/roads ect)


----------

