Hi, I recently found out about construction loans and it excited me at the thought that I could potentially build a custom home faster than I assumed. How exactly do these loans work and are they an efficient way to start things off in terms of construction/cost?
@Derick Passram I am doing something similar at the moment. However I'm in Canada and I'm certain there will be some differences in how the financing structure works. Here's what my project looks like:
In Aug I bought 7 acres of raw land (dream is to finally be able to get an acreage with horses in the backyard) and did 50% down since it was raw land with no services yet. We put a well on it and it now became serviced land, allowing us to refinance the land loan with the same lender (an Alberta credit union) at 75% LTV. From here, we had the option to either get a construction loan (also called draw mortgage here) or to put all of our costs on unsecured lines of credit. We opted for the LOCs and here's what the numbers breakdown sort of looks like:
LOCs: Between my husband and I, joint and separate, we have 8 unsecured LOCs and 4 credit cards (1 very low interest) to float all of our construction expenses. The LOCs range from 4.4% - 8% at the moment (variable rates). We're estimating we'll end up paying about $2000 in interest between our land loan and the LOCs until we can get our mortgage funded. We don't have the same seasoning rules here as you guys do in the US so we can do immediate refinances if there's a clear appreciation in a property. Once our house is complete, we will then get a mortgage + improvements, which will essentially be a regular mortgage but allow us extra cash to do interior renovations, landscaping, and build a garage. We likely won't be able to do all of the above but we can pick and choose.
Draw Mortgage: We were originally planning on going this route, but the costs were quite a bit more than just interest, and we were able to swing it with the LOCs and CCs as back up, so we opted for those instead. There was going to be a fee for registering the draw mortgage on title, about $1200 or so (all $ are in CAD $) in lawyer fees, and our project would have had 3 draws. After each stage of completion/draw, we would have to get it inspected ($300-$400 x 3 draws = $900-$1200), and also for each draw, we would have to get the lawyer to verify the title and add the new amount onto the title, which was also going to be about $500 or so per draw, x 3 draws = $1500. The interest rate on a draw mortgage is higher than a regular mortgage, and similar to those on the unsecured LOCs, so let's say again about $2000.
So for us, costs of using LOCs: $2000 for interest. Cost of using a draw mortage: About $5900.
Also note that our project is a little different than if you want to build from scratch. We did a brand new foundation, 9' basement, and all brand new utility hook ups and set ups, but we actually moved a 1961 bungalow onto the foundation. Once our regular mortgage funds, we will gut it and renovate it. In our case, it works out cheaper than building new, and we saved a perfectly liveable house from going to the dump.
I forgot to also mention that in our case for the draw mortgage, the lender also required us to have 15% of the project's total costs in cash sitting in our bank account as a reserve for overages. Not on a line of credit, cash in the bank.
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