Construction Loans

If you can’t find the right home to buy, you might be thinking about how much it will cost to build a new house or renovate the one you currently call home. The process of borrowing the money to pay for this project is different from getting a mortgage to move into an existing property. Here’s everything you need to know about getting a construction loan.

Construction loan requirements

The companies that offer construction loans usually require borrowers to:

• Be financially stable. To get a construction loan, you’ll need a low debt-to-income ratio and a way to prove sufficient income to repay the loan. You also generally need a credit score of at least 680.
• Make a down payment. You need to make a down payment when you apply for the loan. The amount will depend on the lender you choose and the amount you’re trying to borrow to pay for construction, but construction loans usually require at least 20 percent down.
• Have a construction plan. If you have detailed plans and a project schedule, especially if it was put together by the construction company you’re going to work with, it can help lenders feel more confident that everything will go according to that plan and you’ll be able to repay the loan.
• Get a home appraisal. The finished home will serve as collateral for the loan, so lenders want to make sure the collateral will be sufficient to secure the loan. For that, they may require you to get an appraisal estimating how much the finished home will be worth.

How to get a construction loan

Getting approval for a construction loan might seem similar to the process of obtaining a mortgage, but getting approved to break ground on a brand-new home is a bit more complicated. Generally, if you’re wondering how to get a construction loan, you should follow these four steps:

Find a licensed builder

Any lender is going to want to know that the builder in charge of the project has the expertise to complete the home. If you have friends who have built their own homes, ask for recommendations. You can also turn to the Canadian Home Builders Association to find contractors in your area. Just as you would compare multiple existing homes before buying one, it’s wise to compare different builders to find the combination of price and expertise that fits your needs. The builder must have a new home warranty policy.

Get your documents together

A lender will likely ask for a contract with your builder that includes detailed pricing and plans for the project. You will also likely need to provide many of the same financial documents as you would for a traditional mortgage, like pay stubs and T4’s to prove your income.

Get pre-approved

Getting pre-approved for a construction loan can provide a helpful understanding of how much you will be able to borrow for the project. This can be an important step to avoid paying for plans from an architect or drawing up blueprints for a home that you will not be able to afford.

Get homeowners insurance

Even though you may not live in the home yet, your lender will likely require a prepaid homeowners insurance policy that includes builder’s risk coverage. This way, if something happens during the construction process — the halfway-built property catches on fire, or someone vandalizes it, for example — you are protected.

How do construction loans work?

1. The borrower applies for a construction loan, submitting proof of employment, proof of down payment money, plans and project timelines.
2. If approved, the borrower starts drawing funds in conjunction with each phase of the project, typically only repaying interest during construction. Throughout construction, an appraiser or inspector assesses the build to authorize more funds.
3. Once construction finishes, the borrower usually converts to the loan to a permanent mortgage and begins repaying both principal and interest.

Differences between construction loans and traditional mortgages

Beyond the cost and repayment timeline, construction loans and mortgages have a few main differences:

• The loan money distribution. Unlike mortgages and personal loans that make a lump-sum payment, the lender pays out the money for a construction loan in stages as work on the new home progresses. These draws tend to happen when major milestones are completed — for example, when the foundation is laid or the framing of the house begins.
• The money the borrower owes. With a mortgage, you start paying principal and interest right away. With construction loans, you will typically be expected to make only interest payments during the construction stage. Additionally, borrowers are typically only obligated to repay interest on any funds drawn to date until construction is completed.
• Inspection/appraiser involvement. While the home is being built, the lender has an appraiser or inspector check the house during the various stages of construction. If approved by the appraiser, the lender makes additional payments to the contractor, known as draws. Expect to have between four and six inspections to monitor the progress.

What is the drawing process from your construction loan?

Ask your lender how money gets disbursed from your loan amount. Some lenders allow for monthly draws, while others will only authorize a draw after a passed inspection. Inquire about any processes or documentation required to pull money from your construction loan so that your contractor can use it.

Construction loan lenders

Not all regular mortgage lenders and banks provide construction loans. We have access to 10 lenders who will offer construction financing. Give us a selection of lender to choose from so we can set you up with one that suits your needs.