You are planning to build your own custom home/cottage or do a major renovation. It’s an exciting opportunity and you’ve spent hours pouring over design magazines, watching design shows and searching for just the right finishes. Now it’s time to make the dream a reality and one of the first steps is to determine how you are going to finance the project. We spoke with two local mortgage experts, Pat Kavanagh, Mortgage Specialist at RBC Royal Bank and Debbie Davidson, Mortgage Agent with The Mortgage Professionals, to gather some helpful information and tips. This article shares some of the information you may want to consider when determining how to finance a custom home or cottage. Every situation is unique; so this article is meant as general information only and mortgage rules may have changed since publication. For advice specific to you and your financial situation, please consult a qualified mortgage advisor.
When you have the guidance of an experienced architecture firm behind you, building your own custom home or cottage or doing a major renovation is an exciting process that will result in a space that truly fits your wants, needs and vision. Jim will propose a realistic budget and design a beautiful home, giving you the opportunity to focus on the fun aspects of your new custom home design. From a financial standpoint, it does take substantial resources to finance your own home or cottage build. However, if you own your own home and have significant equity, little or no debt and a good, stable income, the home of your dreams may be within reach.
How does the lender qualify the borrower for a new custom home or cottage?
If you want to live in your current home until your new custom home is complete or you are building a cottage, you are required to prove that you have at least 20% of the total appraised value of the new home (35% for a 3-season cottage) free and clear. You must qualify upfront for the total amount of financing required to carry your current outstanding mortgage plus the amount to be financed for your new project and any other debt you currently carry. If you have an unused balance in your line of credit, that money can be used to finance a portion of the project or can be used as a contingency fund for project changes and additions. The value of your new to-be-built home is determined based on the value of similar homes in the same area and your lender may reduce the amount available if they feel you are “overbuilding” for the area. The lender will take into consideration the reputation and experience of the designer and project manager. Engaging professionals with a proven track record reduces risk. To be approved for the financing of a high-end home build, most lenders will require you to hire a project manager.
How does the financing work during the construction phase?
When providing a construction mortgage to finance a construction project, your lender will do a series of appraisals to ensure that the money being paid out to contractors is in line with the actual value of the work performed to that date. Therefore, after an initial draw to begin the work, there will be a series of appraisals and draws as the project progresses, with a 10% holdback to be returned to you once your home or cottage is 100% complete and the mortgage is capped. A “draw” is the method the banks use to release the money to pay for supplies and contractors as the work is completed throughout the building phase. Typically, a total of 4 appraisals and draws are permitted. If you contract with Bell+Associates Architecture to provide contract administration services, we will manage this process for you, paying invoices as the work is completed and determining the appropriate times to request additional money from your lender. During construction, you pay only the interest on the amount borrowed to date and once your home is complete the principal and interest payments will begin.
Does financing work any differently for a major renovation when compared to a new build?
Financing options are very similar for major renovations. The bank will require detailed plans for construction and before the construction mortgage is approved an appraiser will assess them to determine the expected value of the home after renovations are complete. During the construction process appraisals will be conducted prior to each draw as they are for new custom home builds. A 10% holdback also applies for renovations.
What about using a home equity line of credit?
If you have considerable equity in your current home you can use a combination mortgage/line-of-credit combination product or home equity line of credit to finance a portion of either a new build or major renovation. Particularly if you are downsizing to suit your new empty-nester lifestyle and building a new custom home that is smaller and a lower value than your current home, this can be an excellent option to finance a large portion of the project.
When considering a custom home or cottage project a few years down the road what can clients do between now and then to prepare themselves financially?
It’s not too early to meet with a mortgage expert. They will review various options available and guide you into the next steps. You will then know what you need to do to qualify for a construction mortgage or to finance the project using a home equity line of credit. This is the perfect time to sit down and understand exactly what you have now, identify any shortfalls and develop a plan of action to get you where you want to go. You may need to sell or refinance a property to obtain the necessary funds or you may need to just stay on track with a great savings plan and set up auto deposits to a TFSA. This meeting will provide you with a wealth of knowledge and a better understanding of what is possible.
How should clients prepare for a meeting with a mortgage expert?
It is best to meet with a mortgage expert very early in the process to receive a pre-approval and confirm that you qualify before getting too deeply into the design for your new home, cottage or renovation. It’s important to have a “game plan” and provide a general idea of your vision for the project. Debbie and Pat would both welcome the opportunity to sit down with you to provide more detailed information about the process and recommend the best financing options for you.
They will look at your cash flow and available funds, upfront costs and whether or not you own the building lot. You cannot borrow the down payment. If it’s a gift, the person giving the gift must sign a document to confirm the money does not have to be paid back. In order to facilitate the pre-approval process, bring the following documents to the initial meeting with your mortgage expert:
- Proof of income (e.g., T4s)
- Documents confirming self-employment income (if applicable)
- Investment statements for RRSPs, TFSAs or other savings
- Property tax bill for your primary home
- 90-day history of cash flow (e.g., bank statements)
Design services add value to a project just like bricks and mortar. Do the banks recognize the value added when the client engages a professional architecture firm?
The appraiser most definitely will take into consideration the value of professional design when determining the value of the completed project. The good news is that most people who build their own homes with the help of an architecture firm will build the home for less than the final appraised value. Great design adds value!
Any final words of wisdom?
We don’t want to discourage anyone, but it does take substantial financial resources to build your own custom home or cottage. If you don’t have experience building homes, engaging an architecture firm and qualified general contractor or builder will make it easier to obtain the required financing. The banks offer many options when it comes to building your dream home or cottage. Meeting with a mortgage expert will help you to decide what product is best for you.
If you are embarking on the journey of building a custom home or cottage or you’re considering a major renovation, take a few minutes to chat with Jim Bell. He has over 30 years of experience making dreams come true for hundreds of very satisfied home and cottage owners. He will listen and he will help you to shape your vision. If you are ready to discuss financing with a mortgage expert, he can connect you with Debbie or Pat, who will gladly meet with you to discuss the best financing options to achieve your dream. Connect with us today!