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How Does Pre-Construction Mortgage Work?

Mortgages for pre-construction projects work differently than traditional resale mortgages. You don’t need to get a mortgage until the project is complete and you receive the keys. However, some builders demand a mortgage pre-approval letter to book a unit. No lender will hold a rate for multiple years but this letter works as a proof that you can afford to make payments when the time comes. Before you book a pre-construction project, understand the intricacies of how pre-construction mortgage works. Let’s talk more. 

step by step written on wooden blocks

Step-by-step process of getting a pre-construction mortgage 

When you purchase a pre-construction home, you are essentially buying a promise from the builder that the property will be constructed according to the agreed-upon specifications. Builders in Canada have become aggressive in how they handle mortgages and might ask you for approvals at different stages of the building process.

1. Choose the Property

Choose a pre-construction project only after you visit the sales center, review the floor plans, and understand the builder’s terms and conditions. Depending on the project, you have to pay 5 to 20% in down payment or deposit spread across a few months. Usually, the last chunk of deposit is paid at final closing. 

At this stage, builders might ask you to present a pre-approved mortgage document that holds the rate for a minimum 180 days. This unofficial rule was brought in sometime around 2017 when many purchasers failed to secure a mortgage at final closing and builders had to sell it to other buyers at a loss. 

2. Make Timely Deposits 

During the construction phase, you will make several deposits, which are structured by the builder. It looks something like this: 

  • 5% draft order or cheque at signing 
  • 5% after 30 days
  • 5% after 90 days
  • 5% at completion

These deposits contribute to the overall down payment of the property. If your pre-construction property’s down payment was less than 20%, you are required to get mortgage insurance. It is added to your monthly mortgage payments. 

3. Construction Phase Begins

While the property is under construction, the builder will keep you updated on the progress. This phase can last anywhere from several months to a few years, depending on the project’s scope. You don’t have much to do other than make timely deposit payments and provide any information needed by the builder. Towards the end of the project, the builder will ask you to choose design options and book any upgrades you’d like. We have a detailed blog on pre-construction design upgrades and how to get the bang for your buck. 

4. Pre-Occupancy Stage 

This stage begins 6 to 12 months before final closing and buyers can get possession of the keys and prepare to move-in. Your builder will notify you once this stage begins and is a solid sign that your project will be successfully closed. 

Before the builder hands over the keys, you will be asked to present a firm mortgage approval letter. Your mortgage payment doesn’t start at this stage since the property hasn’t closed. Again, it works as proof that you’ll be able to make a mortgage payment when the time comes.

Read more about the pre-occupancy stage here

You are free to move into the unit. Instead of paying the mortgage, you’ll be paying the builder occupancy fees or phantom rent. It is not counted towards your deposit or property value and is directly paid to the builder. These fees are mandatory whether you move into the unit or not. 

All fees are mentioned in the purchase agreement and are calculated based on interest of the remaining balance, monthly share of municipal taxes, and monthly maintenance fees. These fees work as a cushion for the builder to continue construction and they usually don’t profit from it. 

Here’s a tip for saving some money during this stage. Builders start construction when 60% of the units are sold out. If you’re purchasing in a condo project, they finish units on the lower units first. Let’s say it is a 30-storey building and you purchased a unit on the 3rd floor. Builder will get the unit ready and you’ll enter the interim occupancy stage. 

Now if you would have purchased a unit on the 29th floor, it’ll be one of the last to be finished. So, the occupancy fees you pay would only be for a few months. It works the same way with stacked townhomes and traditional homes built in phases. 

5. Finalize the Mortgage

As the property nears completion, the lender will reassess your financial status to ensure you still qualify for the mortgage. The process from here out is similar to a traditional mortgage. 

Now, let’s understand that there are risks attached aslenders scrutinize a pre-construction property more than resale. Make sure to provide all necessary documents and promptly respond whenever they need more information. We recommend you start shopping around 60 to 90 days in advance and work with an experienced mortgage broker who will bargain efficiently on your behalf. 

Some builders team up with leading banks to create a concessional program for project buyers. You can get a discount of 0.20 to 0.25% interest, which will save you a few thousand dollars in the long run. 

6. Closing Costs and Final Payment

At closing, you will need to submit your firm mortgage document and pay any closing costs. They can include legal fees, land transfer taxes, and other miscellaneous expenses. Read about them in detail here. Budget from them right when you sign the purchase agreement, so there aren’t any surprises later. 

mortgage application with house keys placed on it

Are there any risks that can lead to mortgage rejection? 

Pre-construction projects take up to 3 years to complete and many things can happen during that time. Here are some risks that you must prepare to deal with: 

1. Loss or change of employment

The market is more volatile than ever and sadly, many people are losing their jobs. We hope that you aren’t one of them, but if you are, there sadly aren’t many options that forego the property. If you had to change employment and take a lower paying job, you still have a good chance to be approved by a B lender but at a higher interest rate. 

2. Increased in unit price

Committing to purchase a pre-construction property means agreeing to a fixed price for a future date. However, real estate markets can fluctuate, and property values might decline. If the appraised value at completion is lower than the agreed price, you’ll need to cover the difference in cash. Lenders will not approve a mortgage if they feel the appraised value is higher than current rates of similar properties. 

3. Project delays or cancellations

Only 5% of projects in the GTA have ever been canceled, so the risk is minimal for you. However, project delays are quite common and you can expect 6 to 12 months of delays. It happens due to unexpected weather and shortage of construction materials and labor. 

There isn’t much you can do about it but wait out the period. Review your contract carefully to understand your entitlements if the project is delayed or canceled. If waiting isn’t an option, you can sell it as an assignment. Read here how assignment sales work. 

If you’re considering buying a pre-construction unit, take a look at these projects. Our sales team is happy to provide more information and will find the best project for you.

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