What is Construction Mortgage?

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Construction mortgages or construction loans are short-term loans designed to finance the construction of a home. Construction mortgages require strict qualifications and higher interest rates due to the possible risks associated with the lender. These mortgages demand only the interest to be paid during the construction period. 

Construction mortgages help streamline the building planning process, minimize costs wherever desired, and simplify repayments during the project commencement. 

This article discusses the features and types of construction mortgages. 

Features of Construction Mortgages

• Construction mortgages provide access to around 80% of the funds required for the planned project. The funds are provided during each stage of the construction.
• The first advance is available as equity take-out if the builder owns the land. For those who do not own the land, the first advance is provided to buy appropriate land for constructing the building.
• The below table shows an example of the construction mortgage amount provided during the various construction stages.

Draw Stage	Required Building Completion	Construction Stage	% of Total Mortgage Amount Advanced
1	15%	Excavation and foundation complete	15%
2	40%	Roof is on, the building is weather-protected (i.e., airtight, access secured)	25%
3	65%	Plumbing and wiring is started, plaster/ drywall is complete, furnace installed, exterior wall cladding complete, etc.	25%
4	85%	Kitchen cupboards installed, bathroom completed, doors have been hung, etc.	20%
5	100%	Ready for occupancy with seasonal and exterior work completed	15%

• Prior to each mortgage fund provided, an inspector goes to the property and ensures that the builder follows the New Home Warranty (NHW) policies and evaluates whether each stage of construction is completed with accuracy before releasing further funds.
• Once the mortgage is approved and signed, the amount cannot be changed to accommodate any upgrades or changes made to the home.
• The loan repayment is done in monthly installments, either single-closing or two-closing transactions.

Types of Construction Mortgages

The two main types of construction mortgages are

1. Construction-to-permanent loan 
2. Stand-alone construction loan

1. Construction-to-permanent loan

Construction-to-permanent loan is a one-time closing loan that involves a single-closing transaction. This means it involves one loan application process and one closing. The mortgage approved is for the construction and the completed home.

Until the construction is completed or after 18 months of construction (whichever comes first), only the total mortgage interest needs to be paid. After the structure is completed or move-in-ready, an occupancy certificate is obtained. Then the loan is converted into a permanent mortgage where the homeowner has to pay the regular principal and interest as monthly payments.

The main advantages of single-close loans are that only one loan application and one closing are required for the entire project, with more security.

2. Stand-Alone Construction Loan

A stand-alone construction mortgage is a two-closing transaction, i.e., it involves two loan applications and two closings. 

The first loan is applied for the physical construction of the home. The second loan is applied after the construction of the home, and it is a long-term loan taken on the completed home to refinance the construction loan to 15 to 30 years.

The advantage of a stand-alone construction loan is that it provides lower interest rates and flexibility to apply for any other loan with better interest offers.

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