Construction Loans in Canada 2024
What You Should Know
- Construction loans allow you to finance building custom homes.
- To be eligible, you’ll usually need a credit score of 680 or higher and detailed construction plans.
- You don’t receive the total mortgage value upfront. Instead, you receive payments with each construction milestone.
- Construction mortgage rates are generally higher than conventional mortgages.
Are you a homebuyer or real estate investor in Canada? Ever wonder how you can finance building your dream home or investment property from scratch? This page will walk you through everything you need to know about construction loans in Canada, from the basics to the application process, benefits, and tips for securing one.
What Are Construction Loans?
Construction loans are specialized short-term loans used to finance the building of a new home or substantial renovation of an existing property. This allows you to build your own home from the ground up. You can select a plot of land, design the house, and eventually construct the home itself.
Unlike traditional mortgages, which provide a lump sum for purchasing an existing home, construction loans disburse funds progressively as the building project advances. This method ensures that money is available at various stages of construction for things such as the foundation, framing, and roofing.
Eligibility Criteria for Obtaining a Construction Loan
Similar to a down payment made for a conventional mortgage, construction loans may require you to put money up front to pay for construction expenses. However, unlike conventional mortgages, the collateral for a construction home is an unfinished home. Construction loans are riskier for lenders because they have a lower value and are more difficult to sell than a finished home. To see whether you can afford the construction loan, and eventually afford a mortgage, your lender will look at your income, debt levels, and credit score. Securing a construction loan involves stringent criteria to mitigate risks for the lender. Here's what a construction loan lender would look at:
Creditworthiness
Your credit score plays a crucial role in securing a construction loan. Most lenders in Canada require a minimum credit score of 680, with the minimum requirement possibly being 700 or higher, depending on the lender. Higher scores can secure better terms and lower interest rates, reflecting your reliability as a borrower.
Required Documentation
To qualify for a construction loan, you'll need more than just good credit. Lenders require detailed construction plans, a well-prepared budget, and a timeline for project completion. These documents help the lender assess the feasibility of your project and its financial requirements.
Financial Stability
Lenders will scrutinize your financial stability, including income verification, employment history, and existing debts. They want to see proof of sufficient income to cover both the interest payments during construction and eventual mortgage payments upon project completion.
Applying for and Securing a Construction Loan
Applying for a construction loan is more complex than a traditional mortgage, but understanding the steps can simplify the process.
Step-by-Step Application Process
- Project Planning: Before approaching lenders, have a detailed construction plan, budget, and timeline in place.
- Choose a Lender: Research and select lenders experienced in construction loans.
- Submit Application: Submit necessary documents, including construction plans, financial statements, and credit information.
- Appraisal and Approval: The lender will appraise the project’s feasibility and assess your financial stability before approving the loan.
Disbursement of Funds
Funds are typically disbursed in stages, known as "draws," corresponding to the completion of various construction phases. Each draw requires inspection and approval from the lender to ensure the project is progressing as planned.
Converting to a Permanent Mortgage
Once construction is complete, the construction loan typically converts to a standard mortgage. The terms of this mortgage would generally be agreed upon beforehand. This allows for a smooth transition from construction financing to long-term homeownership or investment property holding.
Why Choose a Construction Loan over a Traditional Mortgage?
Home construction loans differ from regular mortgages in the loan term and when you receive access to the loan. Construction loans are meant to be a short-term way for you to finance your new home construction. On the other hand, mortgages apply to existing homes, can have longer terms, and have lower mortgage interest rates.
Construction loans offer the flexibility that traditional mortgages lack. They are structured to meet the specific needs of a construction project, offering incremental disbursements rather than a one-time, upfront payment. This model helps borrowers ensure funds are available when needed, with borrowers only paying interest to borrow money when they need it.
Most construction loan agreements allow borrowers to make interest-only payments during the construction phase. This can ease the financial burden during the months when borrowers are paying for building materials and labour.
Comparing Construction Loans & Conventional Mortgages
| Construction Loans | Commercial Mortgage | Residential Insured Mortgage | |
|---|---|---|---|
| Maximum Amortization Period | Non-Amortizing | 40 years | 25 years |
| Interest Rates | Highest | Medium | Lowest |
| Maximum LTV | 75% | 85% | 95% |
| Draw Schedule | Typically four draws | One-time lump sum | One-time lump sum |
| Approval Criteria | Detailed construction plans & borrower’s financials | Property income generation & borrower's financials | Borrower’s financials |
How Do New Construction Loans Work?
Construction loans are also called draw mortgages. Construction draws are the process by which your lender provides financing to you, which you will then use to pay contractors and for supplies. Your lender may provide the funds to your lawyer, who, in turn, will disburse the funds to your contractor. Other lenders might only deal directly with the contractor. Regardless of who gets the money from the bank, they usually require a construction plan and a budget for the project. It is important to have a clear and realistic budget to increase the chances of getting the loan. You may talk to the contractor directly or use different calculators to estimate the amount of resources your project requires. For example, you can use a stair calculator to estimate how much material you will need for your staircase and a concrete calculator to estimate the cost of your foundation.
Draws are paid out in stages of the home construction process. This means that the contractor does not receive the entire loan amount upfront to build your home. Instead, the contractor will only receive money proportionate to the completion of the house. This ensures that the construction loan funds are used towards constructing the home.
Most lenders will allow you to borrow up to 75% of the construction cost. This means that you will need to pay for 25% of construction costs out of your pocket.
If you are not using a general contractor or a home builder, a self-build construction loan provides financing if you are building your home yourself. However, you will need to have the necessary experience to do so.
Construction Draw Schedules
A construction draw schedule outlines when construction draws are paid. The contractor negotiates a draw schedule before construction begins. While the bank might already have a standardized draw schedule, your contractor or the bank's appraiser may propose alternate payment schedules. This can be due to differing construction timelines or costs. Construction draw schedules can be based on milestones, such as when the foundation or roof is complete or a general percentage of the total home finished.
Interest only starts incurring once each construction draw is disbursed. As a borrower, you may want to receive draws as late as possible to reduce interest costs during construction. On the other hand, the contractor would want to receive their pay as early as possible. If your contractor or lender proposes an alternative payment schedule, you should review it to ensure that it allows your contractor to be paid on time, but is also reasonable.
Example of a Construction Draw Schedule
| Draw Number | Milestone | Draw Amount |
|---|---|---|
| First Draw (If Land Not Owned) | Purchasing Vacant Land | 65%-75% of land cost |
| First Building Draw (If Land Already Owned) | Excavation and Foundation | 15% of construction cost |
| Second Building Draw | Roof Finished | 25% of construction cost |
| Third Building Draw | Plumbing, Wiring, and Drywall | 25% of construction cost |
| Fourth Building Draw | Interior Finished | 20% of construction cost |
| Fifth Building Draw | Construction Complete | 15% of construction cost |
Example Home Completion Schedule
| Work Completed | % of Total |
|---|---|
| Excavation | 2% |
| Foundation | 6% |
| Framing | 15% |
| Roofing | 2.5% |
| Windows | 3% |
| HVAC | 4% |
| Drywall | 5% |
| Painting | 6% |
| Total | 100% |
How many construction draws can I receive?
Some lenders, such as banks, usually only allow up to four draws. Other lenders can be more flexible and allow a greater number of draws. Your lender will send an appraiser to check on the progress of the home before a draw is paid. An inspection fee can be charged each time, depending on your lender.
Benefits and Drawbacks of Using a Construction Loan
While construction loans offer unique advantages, they also have potential drawbacks.
Benefits
Customization: Construction loans allow for customizing homes or properties from scratch to meet specific needs and preferences rather than buying a pre-built home.
Control Over Quality: Direct involvement in the construction process ensures better control over the quality of materials and workmanship.
Financial Flexibility: Interest-only payments during construction ease the financial burden until the project is complete.
Drawbacks
Complexity: The application process for construction loans is more complex and time-consuming than traditional mortgages.
Higher Interest Rates: Construction loans often come with higher interest rates compared to standard mortgages.
Inspection Requirements: Frequent inspections by the lender can slow down the construction process and add additional layers of bureaucracy.
Examples of Using Construction Loans
Homebuyers in Vancouver
Sarah and John wanted to build their dream home in Vancouver. Unable to find a pre-built house that met their needs, they opted for a construction loan. With detailed planning and a reputable builder, they secured the loan, managed the disbursements efficiently, and successfully moved into their custom-built home within a year.
Real Estate Investors in Toronto
A group of investors in Toronto aimed to construct a multi-unit rental property. They used a construction loan to finance the project, leveraging the phased disbursement to manage cash flow effectively. The project was completed on time and within budget, resulting in a highly profitable investment.
Tips for Homebuyers and Real
Do Your Homework
Before applying, research multiple lenders to compare terms, interest rates, and fees. Understanding the nuances of each lender’s offerings can save you time and money.
Hire Experienced Professionals
Engage a reputable builder and, if possible, a construction consultant. Their expertise can help you avoid costly mistakes and ensure the project stays on track.
Keep a Contingency Fund
Despite planning, unexpected costs do arise. Having a contingency fund of 10-15% of the total project cost can provide a financial cushion.
Construction Loan Financing Programs
Home Improvement Mortgages
You can borrow more on your mortgage for home improvements with an improvement mortgage. Some lenders offer home improvement mortgages, which give you an additional amount on top of the home's purchasing price in order to pay for minor improvements.
For example, Meridian's Purchase Plus Improvement Mortgage allows you to borrow up to 20% of the home’s purchase price, up to a maximum of $40,000, to make home improvements. You will use this mortgage to purchase the home. You will only receive the additional improvement funds once you have completed the improvements, as they are not paid upfront.
Since home improvements can increase the property value, the mortgage down payment required for the mortgage will also increase. The down payment will be calculated on the new value of the property, or the purchasing price of the property plus the improvement costs, whichever is lower.
CMHC Rental Construction Financing
If you are constructing multi-unit rental housing, you may qualify for funding from the Canada Mortgage and Housing Corporation. You can borrow up to 100% of construction costs, with a minimum loan of $1,000,000.
CMHC rental construction financing provides CMHC mortgage loan insurance for free. No CMHC premiums are required. CMHC financing is on a 10-year term with a fixed interest rate, for up to a 50-year amortization period. Only interest payments are required during construction.
The CMHC will charge you an application fee. The application fee is $200 per residential unit for the first 100 units, then $100 for each additional unit, up to a maximum fee of $55,000. For non-residential portions of a building, the fee is 0.3% of the loan amount for non-residential portions if the loan for it is over $100,000. The program is fully explained on CMHC’s webpage for the Apartment Construction Loan Program, which used to be called the Rental Construction Financing Initiative (RCFi).
CMHC Affordable Housing Fund
Previously called the National Housing Co-Investment Fund (NHCF), the Affordable Housing Fund is designed to finance the development of energy-efficient, accessible and socially inclusive housing throughout Canada. The housing can be for mixed-income, mixed-tenure and mixed-use affordable housing purposes. Builders can receive up to a 95% loan-to-cost through low-interest and forgivable loans.
The low-interest loans offer a 10-year fixed interest rate. You can also receive up to a 50-year amortization period. Projects with low cash flow are eligible to receive forgivable loans. However, they will not be prioritized for funding. You can learn more and apply to the program through CMHC’s Affordable Housing Fund.
Laneway House Mortgages
A laneway house is a small detached house built on the same lot of land as an existing house, usually facing a lane at the rear of the property. They help to gently increase density in existing residential neighbourhoods while increasing the range of rental housing options. Some lenders, such as Vancity and Equitable Bank, offer laneway house mortgages to finance the construction of a new laneway house. These mortgages may have relaxed eligibility requirements. For example, Equitable Bank’s laneway house mortgage can consider the potential rental income of the unit when calculating the borrower’s debt service ratio, making it easier to qualify.
FAQs
Do I have to make monthly payments on construction loans?
You still have to make monthly payments on your construction loan, even if construction is ongoing and your home is not occupied. Some lenders, such as Meridian Credit Union, only require monthly interest-only payments during construction. You will be required to make principal and interest payments once construction is complete.
Some construction lenders may even allow you to use future construction draws to pay for interest on the loan.
Can I receive money to purchase land with a construction loan?
If you do not already own land to build on, your first construction draw would usually be used to purchase the land. This first draw can be paid in advance before construction starts and can be from 65% to 75% of the cost of the land. Not all lenders pay the first draw in advance. You might be expected to cover the vacant land purchase cost with your own money.
What happens to a construction loan when construction is complete?
Once construction of the home is completed, the construction loan would either need to be refinanced into a conventional mortgage or paid off in full.
Do contractors receive the full amount of construction advances?
Contractors do not receive the total amount of any construction draw. A construction holdback, required by a province’s Builders' Lien Act, withholds 10% from payments that you make to your general contractor. Once construction is complete, the remaining 10% will be paid to the contractor after a minimum holding period of 45 days. British Columbia’s Builders Lien Act and Alberta’s Builders’ Lien Act have such requirements. The naming of such laws and regulations differ by province, such as Ontario’s Construction Lien Act.
Your contractor has 45 days to file any lien claims against your property after construction is finished. You can be asked to sign a Certificate of Substantial Completion, often done once 97% of the home is complete. You do not have to sign this certificate if you are not satisfied with the contractor's work.
Disclaimer:
- Any analysis or commentary reflects the opinions of WOWA.ca analysts and should not be considered financial advice. Please consult a licensed professional before making any decisions.
- The calculators and content on this page are for general information only. WOWA does not guarantee the accuracy and is not responsible for any consequences of using the calculator.
- Financial institutions and brokerages may compensate us for connecting customers to them through payments for advertisements, clicks, and leads.
- Interest rates are sourced from financial institutions' websites or provided to us directly. Real estate data is sourced from the Canadian Real Estate Association (CREA) and regional boards' websites and documents.