Mortgages for brand new homes aren’t always as straightforward as mortgages for resale homes. Builders need funding to get started on a home build, but lenders are taking on a bigger risk when there’s no physical home to act as collateral. If the buyer backs out of the loan or the builder doesn’t finish the property, the lender is out a lot of money.
Because of the complexities involved with this process, you may be required to take out a special type of mortgage specifically for new construction homes. These are known as either draw mortgages or completion mortgages and here's what you need to know.
The Basics of New Construction Mortgages
Most of the time, people who are buying new homes and making all of the design decisions have to take out a draw mortgage. In this case, the builder is able to “draw” on the mortgage at designated intervals while they’re building. Typically, they take one-third of the money at the beginning, one-third in the middle, and one-third at the end.
A buyer who has a draw mortgage is responsible for making payments on the mortgage as soon as the builder draws on it, typically it is for interest only but there may be draw fees as well. Often, this means they're making payments on two mortgages at the same time: their current mortgage and the one on the home they’re building. Once the new home is finished, the mortgage changes into a more traditional mortgage, and they’re able to sell their current home.
Completion mortgages are quite similar to traditional mortgages. The buyer takes out the full mortgage at the completion of the home. In most cases, builders will only allow this type of mortgage when the buyer is purchasing a quick possession home that's already been completed or will be finished in just a month or two.
In rare cases, builders will allow a completion mortgage on an unstarted home.
Advantages and Disadvantages of a Draw Mortgage
A major advantage of a Draw mortgage is you lock your interest rate in sooner. In an increasing rate environment, this is a big advantage. Draw mortgages protect all parties. The builder does not have to front the money to pay for supplies. The buyer is not stuck paying a full mortgage payment on a home they can’t live in. The lender is not lending an amount of money that would be hard to recoup if someone defaults on the loan. In most cases, this is a win-win-win situation.
However, that extra mortgage payment can be a struggle for some families. Most people want to limit the amount of time they spend paying multiple mortgages. This is the sacrifice you might have to make to have full control over the design of your new home.
Advantages and Disadvantages of a Completion Mortgage
Completion mortgages are great for home buyers because they don’t get saddled paying two large mortgage payments for as much as a year. Since this type of loan comes at the end of construction, the lender isn’t putting themselves at risk.
Builders do have to cover the initial costs on their own, which can seem like a drawback, but it does allow them to place homes in the few lots that haven’t been chosen yet. A good builder will stick with the most popular design choices, so they don't need to worry about not being able to sell the home.
From the buyer’s perspective, the only disadvantage of getting a completion mortgage is they’re usually only available on quick possession homes. This means you don’t have as much control over the look of the home. In some cases, there may still be time for you to make minor design decisions like the colour of paint on the walls, but most of the major decisions, such as layout, have been made for you - this makes quick possessions a great option if you're looking for a beautiful new home fast!
Do You Have a Choice?
Builders typically decide ahead of time which type of financing they prefer. For instance, at Pacesetter Homes, we offer those who are purchasing our quick possession homes a completion mortgage, but anyone building a new home from the ground up will have a draw mortgage.
Of course, you can always choose a builder based on the type of mortgage you want, but that’s incredibly limiting. Ideally, you want to select a builder based on the quality of their work and their ability to create the home your family needs.
Mortgages for new homes can seem complicated at first, but they don’t have to be. Our Area Managers can point you in the right direction and help connect you with a lender who’s experienced in new construction mortgages. They'll be happy to answer any specific questions you might have.