If you’re buying a home in new construction, builders tend to work with two different types of loans – completion mortgages and draw mortgages. Different builders have their preferences. In this article, we will compare a draw mortgage to a completion mortgage.
What is a completion mortgage?
A completion mortgage works exactly like it sounds; the builder receives the proceeds on the day you move in and take possession. When you receive approval for a completion mortgage, the rate that you are quoted is good for 120 days, although depending on the lender and the nature of the promotion, that time may be shorter. It’s important to make sure that your possession date falls within this period to ensure funding of the mortgage.
What if it takes longer to finish the home than the rate hold period?
Occasionally this will happen with a pre-sale or custom home, and that can keep your rate from being locked in. The lender (and insurer when applicable) will fully underwrite your application and provide a commitment for the mortgage. In most cases you will not be able to lock in and guarantee the rate until you hit the 120-day mark from possession. When this happens, the approval will often come with a condition that the mortgage approval is “subject to employment and credit re-check”. This means that the lender may run a new round of documentation checking to see if your ability to pay the mortgage has changed.
What is a draw mortgage?
The builder can start to draw funds from the mortgage proceeds during the construction process. You will gain mortgage approval and receive a rate offer that will remain good for 90 to 180 days. The builder starts ordering permits and building the house while you are still nailing down all the details of the home. You still must fulfill all the conditions from the original mortgage commitment, and once the construction has reached a specific stage, the builder can start requesting funds. That is the point where the rate will lock, along with the mortgage term. If you want to add upgrades and have them funded by the mortgage, you will need to go through the bank or lender before you sign the final mortgage paperwork. If you do not do this, you must pay for the upgrades out of pocket when you take possession.
How does interest work with the draw payments?
Interest accrues from the date of the first draw payment. There are some builders who may assume the interest from that point until date of possession as a perk, so you will want to ask your builder about this during the sales presentation. Banks and institutional lenders will generally charge interest on the amount initially drawn. Private institutional lenders will also charge interest on the drawn amount, but their interest rates are higher than those of traditional lenders. Private individual lenders will usually charge interest on the total amount of the mortgage starting at the time of the first draw.
What are my best options?
A bank, credit union or broker specializing in construction mortgages is your best choice in terms of interest rate and term. If you cannot find assistance with one of these institutions, then private financing can work for your loan.
With a private lender draw mortgage, you generally need at least half of the land value to put down, plus enough capital to make it to lockup – as well as a contingency fund of 10 to 15 percent of the mortgage.
With a private lender completion mortgage, your maximum LTV (loan-to-value) ratio is comparable to what you would need with a typical private mortgage. In many cases, this can approach 30, 40 or even 50 percent and can vary with the property location and type, as well as the size of the loan.
In either private lending scenario, your term generally maxes out at a year or two. The idea is that you will get your credit, income verification and other lending metrics in order so that you can transition to a traditional lender (and take advantage of their lower interest rates) at the end of that term.