Home renovation and rebuild projects are expensive affairs. Most of us are not in the fortunate position to use savings to cover the total expense. Where to find the money for your reno or rebuild can be a major stumbling block. It took us months to work this out. Though frustrating at times, we found a solution that protected us, our home and our lender in a manageable way so we could achieve our ideal home. Given our financial situation, we used savings and a construction mortgage.
What are your options? According to Shirley Breen, Branch Manager of Meridian Credit Union’s Davisville location, there are five options to consider: 1) savings; 2) investments; 3) conventional mortgages; 4) construction mortgages; and 5) private mortgages (i.e., loans taken from individuals or institutions with less rigid requirements than a regular mortgage, such as family). Not all of these will be appropriate, but, depending on your circumstances and credit history, one or more may allow you to go forward with your project.
If you are looking at financing options, here are some important points about the more typical financial resources, which were shared during the recent KAAV LIVING-Meridian joint presentation on planning and financing home renovations and rebuilds. If you are interested in attending a future seminar, please contact me.
The Difference between Conventional and Construction Mortgages
Conventional mortgages are what most of us are familiar with. It is a property loan that does not exceed 80% of the purchase price and the entire mortgage amount is advanced to the homeowner at closing. Depending on the scope of your project, this financial option is likely only appropriate when the renovation or rebuild is occurring on a second property (i.e., the mortgage is on property A, while the work is performed on property B). Why? This mortgage is secured by the total value of the property and the Standard Charge terms require the homeowner to safeguard the value of the property for the duration of the loan. This can cause major roadblocks if you intend to make substantial changes to the property used to secure the mortgage because it requires the lender’s consent. However, when the renovation or rebuild is happening on a second property, the lender is not involved at that property and has no concerns about its changing value.
This option is of limited use because not many of us have a separate property in which we have enough equity to secure a new mortgage, but it might provide a partial source of funds.
Construction mortgages can be an option when you want to leverage the value of the property you are planning the major reno or rebuild on to fund your project. Construction mortgages include terms that address specific lender issues associated with financing a major reno or rebuild on the property that is securing the loan: 1) the change in value of the property during the reno/rebuild process; and 2) the potential that substantial construction liens will be registered on the property title in the course of the project, which will precede the lender’s repayment priority. How is this done? Unlike a conventional mortgage, you do not receive the total value of your mortgage up front. You receive it in draws and are only advanced when the existing property can secure them. In addition, the lender deducts 10 percent from each draw as security to fund holdback obligations resulting from construction liens. Once the project is complete, the holdback is released to the borrower if there are no liens on the property.
While this option allows you to leverage the value of your single property, you will need to ensure that you have adequate funds (like savings) to bridge any financial gaps that may exist between draws. These gaps could arise at the beginning of your project if you cannot use the initial pre-build land value draw to pay the initial project costs required to move forward with the project.
What You Need to Know about Home Equity Lines of Credit
Despite advertising that may suggest these secured lines of credit can be used to finance home renovations, this is not necessarily true. “These lines of credit are usually part of a collateral charge mortgage and are subject to Standard Charge terms that do not permit structural changes to the structures on the securing property” says Ms. Breen. Why? Because changes could negatively impact the value of the property that is being used to secure the mortgage. Unlike a construction mortgage, the home equity line of credit is not designed to manage this possibility or ensure proper holdbacks are retained by the borrower in the event of construction liens. If you are thinking about using a home equity line of credit to finance your renovation, contact your lender to learn what would be permissible in your circumstance.
Financing is very technical and daunting, but not impossible. It’s just one of the gates you have to pass through on your way to achieving your ideal home! Need guidance on how to create a budget for your project and where to find the money for your reno or rebuild? We can help.
Disclaimer: The above information is intended to be a general overview. It does not constitute legal or mortgage advice. It is always advisable to consult legal counsel or mortgage institution to determine your specific situation.