There are many reasons why someone would choose to build a new home instead of buying an existing one. The builders might want something customized perfectly to their lifestyle, to reduce maintenance, to lower energy costs over the long term, or they might simply want to avoid the stressful process of purchasing a home in a hot market.
No matter the reason, if you are set on building a new home, a construction loan is often the best way to get started. To pay for the construction itself, a traditional mortgage loan is not an option. Construction-only loans are just that; they are loans that cover the cost of construction period, and carry their own interest rate and payment terms. Construction-to-permanent loans are slightly different – they include both the construction loan and the permanent loan to pay it off.
Before jumping into how refinancing works or how to find the right mortgage lender for you after construction is finished, let’s take a deeper look at what a construction loan in Ontario actually is.
What is a Construction Loan?
Construction loans (sometimes referred to as “self-build loans”) are just what they sound like: short-term loans used to finance the building of a home.
Construction loans are considered higher-risk loans because they are not backed by the same quality of collateral, as you would see with a traditional mortgage. Repayment is also due fairly quickly. For this reason, the downpayment on a construction loan can be hefty, with typical percentages coming in as high as 20%-25% of the total estimated construction cost. Repayment of the construction loan is due immediately after the construction period comes to an end.
This high bar for entry is one reason why some people don’t consider a new construction loan and opt for the purchase of an existing home instead, complete with a traditional mortgage. If your credit report changes between the start of the build and the end of the build, you could have trouble refinancing your loan, leading to higher interest rates.
Refinancing Your Construction Loans
In many cases, the person or company taking out the construction loan will also negotiate a traditional mortgage to pay off the construction loan at the end of the build. This is called a “construction-to-permanent” loan. Very often, they receive both the construction loan and the mortgage from the same lender for convenience.
In this case, instead of a two-step process, in which a borrower must pay closing costs twice, a more streamlined agreement is reached, and refinancing is not necessarily required. However, for this convenience, the lender gets a little bit of leverage when negotiating the interest rate of the traditional mortgage, and may not give you as good a deal as you would find elsewhere.
Others may prefer to separate the process into two parts, a construction-only loan, and then a mortgage to pay that off, hoping to find a lender that will offer them a lower mortgage rate than they would find in a construction-to-permanent situation. There is a danger in doing this, because the average construction project takes 18 months to complete, and economic conditions (or your financial readiness) might change. Higher interest rates could raise the overall cost significantly over the long term, and you might not find the low rates you wanted by shopping around.
If you used the same lender to finance the construction loan and related traditional mortgage, you can’t really refinance. If you did not do so, you will be refinancing, perhaps using online loans in Canada to find the best borrowing options, with interest rates that better fit your needs.
How Soon Can You Refinance a Construction Loan?
If you only have a construction loan, you can and must find a new mortgage to pay it off at the end of the build. In this sense, you are not re-financing, but financing for the time by negotiating the traditional mortgage with the lender of your choice once the construction period is over.
If you have a construction-to-permanent loan, you have effectively already negotiated two loans in advance (the construction loan and the subsequent mortgage to pay it off), and you can refinance. In this case, you may threaten to walk out on your first agreement unless the lender matches the lower rate you found elsewhere for your traditional mortgage.
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