Mike Cara

Construction Mortgages in Peterborough: How to Finance a New Home Build

Building your own home can be an exciting project, but financing new construction is very different from obtaining a mortgage to purchase an existing property.

With a conventional home purchase, the lender is financing a completed asset. The house exists, its market value can be established through an appraisal, and there is an established market of potential purchasers if the mortgage goes into default.

Construction financing is different.

During construction, the lender is financing an asset that is constantly changing. A property consisting of land and a partially completed house presents considerably more risk than a finished residential property.

That difference affects how much a lender will advance, when the money is released, the interest rate, lender fees, appraisal requirements, legal requirements and the overall structure of the mortgage.

If you are planning to build a home in Peterborough, the Kawarthas or Central Ontario, the financing should be planned before construction begins.

The Land Is the Starting Point

For private construction financing, there is one important requirement borrowers need to understand:

The building lot needs to be paid in full.

The equity in the land provides the foundation for the private lender's security and represents the borrower's initial equity in the construction project.

For example, if you own a building lot worth $200,000 with no mortgage registered against it, you already have $200,000 of equity supporting the construction project.

As the lender advances construction funds and the house takes shape, the lender's security becomes the combined value of the land and the improvements made to it.

If there is already a mortgage against the land, the private construction lender does not have the same security position. Existing financing reduces the available equity and leaves another lender ahead of the construction lender on title.

For the private construction financing I arrange, the land needs to be owned free and clear before the private construction mortgage is established.

Construction Financing Should Be Planned Before You Start Building

One of the most important steps in a construction project is establishing the financing strategy before construction begins.

That does not necessarily mean every dollar has to come from one source.

A construction financing strategy can include the equity in your building lot, personal funds, equity from another property, a home equity line of credit, conventional construction financing and private mortgage financing.

The important question is simple:

Where will the money required to complete the house come from?

Running out of money halfway through a construction project creates a very different lending problem from arranging the financing before construction begins.

A partially completed house is considerably more difficult to finance than a completed home. A new lender must evaluate the work already completed, the remaining construction budget, the current as-is value, the borrower's available equity and the lender's exit risk.

How Conventional Construction Mortgages Work

Banks and credit unions commonly structure construction financing using progress draws.

Instead of advancing the entire mortgage at closing, the lender releases money as construction reaches predetermined stages, such as foundation, framing, lock-up and substantial completion.

There is an important reason for this beyond simply confirming that construction is progressing: Ontario's Construction Act and the risk of construction liens.

Contractors, subcontractors and suppliers who have not been paid for work or materials can have lien rights against the property. Those lien claims can create statutory priority issues that directly affect the mortgage lender's security.

That is why a construction lender does not simply hand the borrower the entire mortgage and wait for the house to be completed.

Before subsequent construction draws are released, the lender's lawyer conducts the required title review to determine whether construction liens or other registrations have appeared against the property. The lender also requires evidence of construction progress and deals with the applicable statutory holdback requirements.

Each draw can therefore involve:

• A progress inspection or appraisal confirming the stage of construction and current value
• A title search for registered construction liens and other registrations
• Lawyer involvement before funds are released
• Applicable statutory construction holdbacks
• Confirmation that sufficient property value exists to support the lender's outstanding advances
• Additional legal, appraisal and administrative costs

This process protects the lender from continuing to advance money into a project where unpaid contractors, subcontractors or suppliers have created claims against the property.

It also explains why construction financing is fundamentally different from a conventional residential mortgage.

The lender is not simply underwriting the borrower once. It is continually underwriting the property, the construction progress, title and its security position as the project advances.

Why Lenders Care About the Current Value

Loan-to-value, or LTV, is particularly important with construction financing.

Suppose a partially completed house and land have a current as-is appraised value of $500,000.

A lender prepared to advance 65% of the current value would limit its exposure to approximately $325,000.

The completed property could ultimately be worth considerably more, but the lender still has to consider what its security is worth today and what would happen if construction stopped tomorrow.

This is one reason borrowers can encounter financing problems when an as-is appraisal comes in below expectations.

The project can remain financially viable, but the financing structure has to reflect the value of the property at its current stage of construction.

What Happens When the Appraisal Changes the Original Plan?

A lower-than-expected appraisal does not automatically mean the construction financing has failed.

Sometimes the structure simply needs to change.

For example, assume a private lender is prepared to commit $400,000 to complete a project, but the current as-is value does not support releasing the entire $400,000 immediately.

Rather than reducing the total financing commitment, the lender can structure the mortgage so that:

$300,000 is released initially, while another $100,000 is held for a subsequent construction advance.

The borrower still has $400,000 committed to the project.

The difference is when the final $100,000 is released.

This distinction is important.

A construction holdback does not necessarily mean the lender has reduced the mortgage commitment. It can simply control when a portion of the committed funds is released as construction progresses and the lender's security improves.

Why Not Simply Advance the Entire Mortgage?

Consider a property with a current as-is value of $505,000.

Immediately advancing $400,000 represents approximately 79% LTV against the property in its present condition.

Advancing $300,000 initially represents approximately 59% LTV.

That is an enormous difference from the lender's perspective.

The remaining $100,000 can be released as construction progresses and the value of the lender's security increases.

The borrower has certainty that the money has been committed, while the lender avoids immediately advancing almost 80% of the current value against an unfinished house.

This is a practical example of how private construction financing can be structured around the realities of a project rather than simply declining the application.

Why Partially Completed Homes Are Difficult to Finance

Mortgage lending ultimately comes down to risk.

A lender must ask a basic question:

If this mortgage goes into default, can we sell the property quickly and recover our money?

A completed residential home has a broad market. Families, investors and other conventional purchasers can buy it.

An unfinished house has a much smaller potential buyer pool.

A purchaser taking over a partially completed project has to determine what work remains, how much completion will cost, whether the existing work was completed properly and how long it will take to finish.

That substantially reduces marketability.

If the lender has to realize on its security, it could therefore be selling an unfinished construction project rather than a conventional home.

This explains why conventional lenders are reluctant to enter a construction project after substantial work has already been completed unless the borrower can provide additional security.

Private Construction Mortgages

Private lenders fill an important gap in the construction financing market.

They can consider transactions that do not fit conventional bank or credit union guidelines, including partially completed projects.

However, private lenders are still lenders. They are not financing construction simply because a bank declined the application.

They evaluate the land, current as-is value, construction budget, amount required to complete the project, loan-to-value, borrower and exit strategy.

The paid-for building lot is particularly important because it provides the initial equity supporting the mortgage.

Private construction financing is also not inexpensive money.

Interest rates are higher than conventional residential mortgage rates, and borrowers should expect lender fees, legal costs and, where applicable, mortgage brokerage fees.

Private construction financing in this market can be priced in the range of approximately 9% to 10%, with lender fees added to the transaction. Actual pricing depends on the property, loan-to-value, stage of construction, location, exit strategy and overall risk.

The relevant comparison is not between a private construction mortgage and an advertised five-year residential mortgage rate.

They are financing two completely different risks.

Private Lenders Look at the Exit Strategy

A strong construction financing application requires more than an appraisal.

The lender wants to know how the mortgage will ultimately be repaid.

The exit strategy can include completing the property and refinancing with a conventional lender, selling the completed home, or using other available assets or financing.

Experienced private construction lenders also understand what happens when a project does not go according to plan.

Many lenders active in this market have backgrounds in construction, development or real estate. That experience allows them to assess construction risk differently from a conventional residential mortgage lender.

They understand construction costs, completion risk and the marketability of an unfinished property.

That expertise matters if the project goes into default. The lender is not dealing with a finished house that can simply be listed for sale. It is dealing with an unfinished construction project that can require additional money and expertise to complete before the lender can recover its investment.

The Cheapest Financing Is Not Always the Best Financing

Borrowers naturally focus on interest rates, but construction financing requires a broader analysis.

The first question should be:

Will the financing provide enough money to complete the project?

A lower interest rate has little value if the lender will not advance enough money, requires a construction milestone the borrower cannot reach without additional capital, or will not finance the project at its current stage.

Certainty of capital can be more important than a small difference in interest rate.

This is particularly true once construction has started.

Running out of money with a house 40%, 50% or 70% complete can leave a borrower with very limited financing options.

Know the Cost Before You Start

If private financing forms part of your construction strategy, understand the cost before construction begins.

That means discussing:

• Interest rate
• Lender fee
• Brokerage fee
• Legal costs
• Appraisal costs
• Progress-draw or inspection costs
• Holdback requirements
• Prepayment terms

Private financing should not become a financial surprise halfway through construction.

The financing structure can change if the property's value or construction progress differs from the original assumptions, but the anticipated cost of private capital should be understood at the beginning.

Construction Financing in Peterborough and the Kawarthas

Construction projects throughout Peterborough, the Kawarthas and Central Ontario present their own financing considerations.

Properties can include rural acreage, wells and septic systems, custom homes, owner-built projects and properties that do not fit standard urban residential lending guidelines.

There is no single construction mortgage that works for every project.

The financing has to be structured around the borrower, the land, the current stage of construction, the completed value, the amount required to finish the project and the exit strategy.

That is why construction financing requires planning before construction begins.

And when circumstances change during construction, the answer is not necessarily to abandon the financing strategy.

Sometimes the solution is simply to restructure how and when the money is advanced.

Need Construction Financing in Peterborough?

If you are planning to build a home in Peterborough, the Kawarthas or Central Ontario, speak with me before construction begins.

For private construction financing, the starting point is a building lot that is already paid in full. From there, we can assess the construction budget, available equity, projected completed value and financing required to complete the project.

If construction is already underway, the financing becomes more complex, but there can still be private lending options depending on the current value, remaining construction costs and available security.

With more than 30 years of experience in finance, I structure mortgage solutions around the transaction rather than trying to force every construction project into the same lending box.

Your Mortgage Advocate,

Mike Cara

Mortgage Broker in Peterborough