A construction loan in Ontario allows you to borrow money to finance your home construction instead of purchasing an existing one. This gives you the ability to build your house from the ground up. Indeed, you will have the chance to choose a plot of land, design your own home, and get it constructed according to your preferences.
Home construction loan vs. mortgages
A home construction loan differs from a regular mortgage in how you access the borrowed money and the loan term. Generally, construction loans are a short-term option to finance a new home construction project, with the borrowed money disbursed in various phases of home construction. On the other hand, regular mortgages apply to existing homes, have low mortgage interest rates, and often have longer terms.
What to consider when choosing a construction loan in Ontario
Before you sign up for any construction loan in Ontario, here are important factors you must consider.
1. The cost per square foot of constructing a home
Depending on the specific type of home you plan to construct, there will be a significant difference in the property construction expenses. Homebuilders offer various types of home construction plans – custom-build homes and stock homes.
Stock homes are often pre-designed to build efficiently, but you will have less control over the property’s design or construction plan. On the other hand, custom homes are entirely designed to meet your preferences. However, they’re more expensive compared to stock homes in terms of the cost per square foot. This is why you should consult with a mortgage broker or real estate agent who understands construction loans to help you evaluate the home construction cost and make an informed choice.
2. Construction draw schedule
A construction draw schedule highlights when the construction draws should be paid. While the bank (construction loan lender) might have a standardized construction draw schedule, the bank appraiser or your contractor may propose a different schedule due to differing construction costs or construction timelines. Remember, a construction draw is often negotiated before a contractor begins the home construction process.
Construction schedules are based on various construction milestones, such as when the home’s foundation or roof is complete or a specified percentage of the home is completed.
Note that the loan interest only starts incurring once a construction draw is disbursed. You, the borrower, may want to receive these draws as late as possible to minimize interest costs during home construction. Similarly, your contractor may want to get their payment as early as possible. So, suppose your lender or constructor proposes an alternative construction draw or payment schedule. In that case, you must review it to ensure that the proposed schedule is reasonable and allows your contractor to get paid on time.
Most banks (lenders) usually allow four construction loan draws. Other lenders may be more flexible and facilitate a higher number of draws. Remember, your lender will send a qualified appraiser to evaluate the home construction process before each draw is paid. Depending on your lender, the appraiser might charge an inspection fee each time.
3. Your construction loan eligibility
Similar to the down payment required for conventional mortgages, a construction loan in Ontario may require you to put a specific amount of money up front to pay for your home construction expenses. But unlike a conventional mortgage, the collateral for construction loans is the unfinished homes. Given that an unfinished home has a lower value than a finished home, construction loans are riskier for lenders such as banks.
To determine if you are eligible for a construction loan in Ontario, banks and other financial lending institutions will evaluate your income, credit score, and debt levels. Note that the eligibility requirements for construction loans in Toronto and across Canada are stricter compared to regular mortgages.
As mentioned earlier, a construction loan in Ontario allows you to finance the construction of a custom home. While you won’t get the total loan value upfront, you will receive payments (draws) with each completed construction milestone.
Remember, construction mortgage rates are relatively higher than conventional mortgage rates. This is why you should consult with a realtor who can help evaluate various construction loan financing programs such as CMHC construction financing, home improvement mortgages, and the Quebec downtown housing grant program and choose a program that best suits you.