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MORTGAGES & FINANCE: Residential Construction Financing

In the residential market, construction financing is available for customers who are planning to build a new home or who want to reconstruct an existing property to become like a new one. Construction financing, in theory, is a permanent conversion of financing dollars in to the construction of new amenities or developing an existing asset. There are several types of construction financing. However, there are options to take into consideration prior to; like hiring a contractor or contractors to remodel your house, or you may choose to develop it yourself, and its at the tossup of just buying a newly constructed home.

Building your own home can be regarded as one of the most satisfying or terrifying endeavors in your life. Nevertheless, there are customers who want to enter into an agreement with registered home builders to build their home. You may purchase or build a home by using a residential home builder who usually develops a community of houses. The customer gives a down payment for a certain and agreed amount at the time of submitting the offer to purchase the property. Oftentimes, the down payment will be given on an installment basis. Once the house is complete, the remaining amount due will be provided by a mortgage or the customer’s savings.

For instance, the customer submits an offer to purchase from the builder. The house is $200,000 with a down payment of $20,000 payable in 3 months. The down payment will be paid by the customer from its own resources and the remaining balance of $180,000 will be paid from the customer’s savings or by way of a mortgage financing once the property is ready for occupancy and closing. This is a single advance mortgage which is similar to a residential mortgage. This is the so-called completion mortgage for one type of construction financing wherein the financing will be provided once the house is 100% complete.

The other type is a Progress Draw Mortgage which is a type of funding that consists of interval payments for the construction of the house being built. There are usually 3 draws of payment for 35%, 65% and 100% of completion. A Land Draw, which is considered unconventional, may be required if the customer is also purchasing the land by way of a mortgage financing arrangement.  In this case there will be an initial draw to pay for the land. This type of construction financing always requires a seasoned Lawyer.  Please call the lawyers at Levy Zavet PC to discuss and assist in your Progress Draw Construction financing arrangements.

A Progress Inspection Report is also needed for each draw wherein the details of the percentage of the completion are required before the advancement of funds. The mortgage or funding broker is the one responsible for contacting the appraiser who will order the inspection report to be forwarded to the construction financiers managing the draws after receiving and evaluating the Inspection Report. This process can be entirely managed by the lawyers for the financiers or the borrower. This is also applicable if the mortgage is insured. The financier/lender will forward the inspection report to the Canada Mortgage Housing Corporation (CMHC) or Genworth Financial Canada (Genworth) who may also perform their own inspection.

Interest will be incurred on all advanced funds at the specified mortgage rate.  Some Progress Draw Mortgage arrangements will also specify a reserve mortgage rate for the unadvanced funds.  This interest rate for unadvanced funds is usually lower than the interest rate charged on the advanced funds.  The reason why financiers/lenders charge an interest rate on the unadvance funds is becuase of the fact that although these funds are yet to be advanced they are still held on reserve for the borrower to use; holding these funds in reserve is an opportunity cost to the financier/lender.

The financiers/lenders designate 2 mortgage numbers in a progress draw; one that represents the actual draw of funds and the other is the final advance of funds. As soon as the house is 100% complete and the final funds have been advanced, the mortgage number 2 is the completion mortgage. The final advance will not be released unless the final inspection took place to confirm its completion. The final mortgage document must be duly signed by the customer/client and must be returned to the financier/lender by the lawyer.

For most Progress Draw Mortgages in construction financing, the cancellation fee is 5% of the outstanding mortgage amount if the mortgage is paid out prior to the completion or the final draw. This will usually be included in a clause in the mortgage document.

There are usually three conventional stages for Progress Draw Mortgages in building a house.

  1. Roof Stage or Roof Tight. This is approximately 35% wherein a survey is required to obtain the first draw.
  2. Intermediate Stage or Lock Up. This is approximately 65% complete wherein the well and septic, if any, is required at this stage.
  3. Final Occupancy or Completion. The lenders will not issue the final advance unless home is 100% complete. However, there is usually a season hold-back of a 3% allowance (that was over time held back from the total mortgage amount). This season hold-back is to be used in case of minor interior and exterior related work needed prior to or at completion.

These draws of funds will be issued solely based on Appraiser’s Percentage Completion Report.

Usually, the required documents needed for any Construction Financing program are:

  1. Written employment and income confirmation documents;
  2. Proof of down payment;
  3. Copies of all contractor quotes if self-build;
  4. Signed contract with builder and all addendums if applicable;
  5. Offer to purchase for land or copy of title if already owned;
  6. Details of any charge registered against owned land;
  7. Full appraisal; and
  8. House specifications, drawings and plans;
  9. Fire Insurance certificate or binder;
  10. Third party warranty information, if applicable, for the construction liability and protection.

Anyone thinking of substantially renovating their home or constructing a new build should contact the lawyers at Levy Zavet PC.