The Urban Dictionary of Construction and Pre-Construction Mortgages
Construction and pre-construction mortgages…what does it all mean? Aren’t they the same thing, except one has “pre” at the beginning? Not quite. Let’s explore these concepts together.
Deep Dive into Pre-Construction Mortgages…
A pre-construction mortgage applies to new build properties – usually townhouses and condos. When you purchase a pre-construction property, you are essentially buying a promise from the developer to deliver the project by a specified date. These types of properties typically offer lower price tags than already built properties, which could lead to higher resale margins in the future. To put it simply, you are buying a property at today’s price for tomorrow’s valuation. It is a risk and reward scenario you will need to weigh out prior to completing the purchase.
In today’s real estate markets, bidding wars on properties are common. People are bidding above asking and inflating the market price. When you choose a new build with a pre-construction mortgage, you’re looking at paying a set price with a fair market valuation. This factor is a significant benefit today!
The typical mortgage approval process is required for pre-construction mortgages, as this indicates to the developer your plans to finalize the transaction. With a pre-construction mortgage, you begin making payments to the developer prior to occupying the residence. Pre-construction mortgages usually require a 20% down payment. However, with this type of mortgage, you can stagger payments. Initially, a small amount is paid upfront, and the remaining down payment balance can be paid on a schedule leading up to the final closing.
A pre-construction loan begins on the property’s final closing date, NOT the date of occupancy – this may start 3-6 months prior to occupancy. During this period, you are paying the developer occupancy fees. Once you move into the property, your “normal” mortgage will start.
What is a Construction Mortgage?
A construction mortgage is a loan an individual can take out to finance the construction of a new home, land purchase for a new build, or refurbishment/repair of an existing home. It is typically financed on a one-year term, before transitioning into a standard mortgage once the home is complete.
Construction loans have a maximum one-year amortization period before they transition to a traditional mortgage. This is because a construction mortgage offers payment flexibility with interest-only payments. Finances are dispersed incrementally from the lender as the building phase progresses. Once the property is completed, the mortgage will transition into a standard mortgage with principal + interest owing on the mortgage; this is known as a Construction-to-Permanent loan. Once the one-year period has reached maturity, then principal + interest is applied to ensure the lender is being paid back.
Because construction loans are short-term (i.e., one year or less), the interest rate applied is variable and fluctuates as the prime rate changes. This could make it difficult to predict costs throughout the construction period. Unlike traditional mortgages with pre-payment penalties, a construction mortgage may not penalize you for early payment of the remaining balance. This is dependent on the lender and signed agreement. In the long-term, this would save you money paid to interest on the loan.
To put it simply…
Pre-construction mortgages are like the show Shark Tank. The developer is the hopeful entrepreneur with the great idea (i.e., pre-development housing), and you are the shark. The developer markets to you through advertising, word-of-mouth, or through multi-media channels. As the shark, you get to decide if you want to invest your money in the pre-development. Harness your inner Kevin O’Leary or Mark Cuban and say “yes” or “for that reason, I’m out.” The down payment is your initial equity stake in the company/pre-development. For fun, walk out of your pre-construction mortgage approval process to the theme song of Shark Tank.
Contrarily, construction mortgages are the magical world of making your Pinterest mood boards come to life. You get to design your dream home from the ground up and have input in the decision-making process throughout the construction period. Once your dream board has come to life, then you’ll start paying a “normal” mortgage.