Construction and Renovation Mortgage

Perhaps the best way to describe how a construction mortgage works is how the average home is built: It’s put together pieces at a time, starting with the foundation, then the framing, clapboards and so on.

Unlike a purchase mortgage, in which the seller receives a lump sum from the lender, with a construction mortgage, the developer receives the funds to pay for the parts and labor over time in installments or “draws.” Paying out the funds in stages – rather than all at once – provides greater clarity and assurance that production and progress is taking place on an ongoing basis.

In addition to the proceeds of a construction mortgage paying for the cost of building and development, the funds also go toward the purchase of the land, assuming that the land isn’t already owned by the borrower.

In terms of when or how these funds get distributed, much of this depends on the lender’s arrangements with the builder and homeowner. Generally speaking, though, it is contingent upon progress and hitting benchmarks. In other words, if the builder requests more funds, the lender will send someone out to assure that work is complete. If things are going as planned, the added funds are released.

Construction mortgages come in many different types or offerings. The one that most people think of are called construction-to-permanent. Much like its name suggests, a construction-to-permanent loan provides the funds necessary to build the home as well as the permanent mortgage financing once the home is complete. Occupancy for a construction-to-permanent mortgage is primarily for owner occupied residences. Construction loans are taken out assuming that the home will be the primary residence of the borrower.

In some instances, a vacation home or investment property requires additional considerations.
Other construction loan options include construction-only, owner-builder and renovation loans. While a construction-to-permanent mortgage is for projects that are large in scale and scope – starting at the ground floor – a renovation loan is designed for projects that are much smaller in terms of work as well as actual financing.

So, if you’re looking to refurbish your bathroom or kitchen, replace carpeted flooring with hardwood or add a second floor, a renovation would likely be a better option than a construction mortgage.