A dream to possess a property holding is one of the most exciting steps that someone can take. However, when it comes to finances, the options for vacant land mortgages and construction loans are a little complicated. Understanding the differences between them makes all the difference because they both cater to certain needs while providing terms that correspond to unique situations.
In this blog, we will break down what you should know about these mortgage types and guide you on how to decide which one works best for your land purchase or construction project in Canada.
Definition of Mortgages
A. Mortgage on Vacant Land
A vacant land mortgage is marketed especially for the purchase of land that is not developed or without a building. Such plots range from farmland, and agricultural lands, to suburban lots. Vacant land mortgages are the favorite of buyers who do not plan to develop it immediately but wish to preserve the land for future use. You may buy vacant land as an investment, to build a home in the future, or for recreation.
Although they typically require a larger down payment, usually between 25% to 50%, and often have a higher interest rate than other mortgages, vacant land mortgages are riskier for the lender. Additionally, some banks and credit unions do not offer land loans for certain types of property-raw land without utility or infrastructure.
B. Construction Loan
A construction mortgage-or construction loan-is a source of funding for the building process of a new home, renovation of an existing structure, or large construction projects. Contrary to a traditional mortgage, which allows a single lump sum, construction loans pay out funds in progressive draws based on the progress of the building project and the achievement of certain building milestones. These loans can be used for material, labor, and even permit costs associated with the construction process and cover the entire building process.
Most borrowers pay interest-only payments during construction. At completion, one can convert the loan into a permanent mortgage or traditional mortgage where one starts paying both interest and principal. The final terms of the loan depend on the overall value of the property at completion.
Key Differences
Purpose of the Loan
The primary difference between the two mortgage types is that one serves a purpose while the other doesn’t.
Vacant Land Mortgage:
This whole idea is to acquire some undeveloped land for future use or investment.
Construction Mortgage:
This type of loan is only strictly offered for building a house or reorienting an old construction.
Every mortgage meets the needs of buyers differently. If you wish to buy land, but only later begin to start building, there’s a vacant land mortgage. If you’re ready to start digging the foundation for that new home, though, a construction mortgage will be more aligned with what you want.
A. Loan Structure and Terms
Generally, land mortgages that are vacant offer a higher interest rate and higher down payment than construction loans because purchasing land is a much more hazardous proposition from the lender’s perspective, especially when the land is not built out or is rural. Land loan interest rates can range anywhere from 4% to 10% based on the LTV and borrower qualification.
In contrast, construction loans operate on a draw schedule wherein funds are released at various stages of the building process. Construction loans are also typically very short-term-that is for between 6 to 24 months, with some issuers providing some form of interest-only payments during the construction phase. After completion, the loan can either be converted into a permanent loan or repaid in full.
B. Understanding Construction Draw Schedules:
The portion of construction mortgages defining how the lender will make disbursements as construction mortgage works progresses is known as the draw schedule. It is common with draw-related loans for the lender to make a few stages, or “draws,” such as for completion of the foundation, framing, and final inspection stages. Every draw includes an inspection to make sure the work is satisfactorily completed before the next part of the funds is released. This process helps mitigate lender risk by ensuring funds are being appropriately used for the construction project and helps borrowers manage their cash flow during the build process. Borrowers should work closely with their general contractor and loan officer to keep the drawing process smooth and efficient.
C. Acceptance Criteria
Approval criteria also vary highly among the types of loans. For instance, where a mortgage on vacant lands is given, mainly the value of the land and its ability to be developed determines the granting of the loan. Funding for land in areas with minimal infrastructural development such as raw land and rural areas would be a difficult thing to come by.
In a construction mortgage, the lender must scrutinize your detailed construction plans, contractor qualifications, and project timelines. This is because lenders would want to establish whether the project is workable and if it can be turned into a property with value at completion, justifying the loan. There is also a requirement for lenders to provide detailed financial statements and proof of income, as construction loans tend to be riskier for lenders.
Financing Options
A. Down Payment
It normally has a down payment that is higher on a vacant land mortgage, ranging from 25% to 50% of the value of the land. The down payment depends on several considerations, such as the type of land, its locality, and whether the land is already zoned for residential or commercial use.
Construction loan down payment: The down payments for construction loans are usually lower, at about 10% to 30%, depending on the qualifications of the lender and the borrower. You could even use the equity of your land that you may own as a down payment for a construction loan amount in which you might not need to put anything down if you already have a plot of land.
B. Interest Rates
Vacant land mortgages tend to come with higher interest rates due to the higher risk. For instance, raw land with no infrastructural development generally carries an interest rate that is mostly higher than 6% to 10%, whereas partially developed land may enjoy lower interest rates.
Construction loans may also have a lower interest rate during the construction phase, but that might be one of the reasons it can shift. The final rate will depend on whatever is available in the market at the time of loan conversion into a permanent mortgage. As the construction progresses, usually, lenders will reassess the loan to set new interest rates according to the current value of the property.
C. Surcharge and Other Fees
Vacant land mortgages and construction loans do carry extra costs on your side. With a vacant land mortgage, you will have to shoulder the cost of getting the appraisal of the land cost, environmental assessments, and legal fees concerning the land. Closing costs apply for vacant land as well, which may include land transfer taxes.
Inspection charges would be extra charges in a construction mortgage since lenders require routine inspections before each draw can be released. Therefore, these inspections will ensure that the construction process is going according to plan. You may also face higher closing fees since construction loans require more frequent involvement of the lender.
When to Choose Each Option
A. Circumstances Favoring a Mortgage on Vacant Land
A vacant land mortgage is very convenient for the buyer who buys land with an investment purpose, who will hold it for future development or use for recreational purposes. As such, if you are buying land in the countryside and building a dream home sometime later on, a vacant land mortgage lets you secure the property until you are ready to begin construction.
B. Situations Favoring a Construction Mortgage
It is preferable for construction mortgage takers who have a serious plan to put up a house or carry out massive renovations. In cases where one already owns the land or has a property to renovate or build, a construction mortgage can take advantage of flexible financing throughout the building process. Construction loans are particularly invaluable when constructing a dreamhouse or undertaking a very large project that needs staged funding.
Risks and Considerations
A. Risks in Vacant Land Loan Mortgages
One of the most significant risks is market fluctuation for vacant land mortgages. The values of land purchase can vary significantly, especially if one is buying in a speculative or unexplored area. Additionally, vacant land is more susceptible to higher interest rates and stiffer loan terms. Buyers have also to establish whether the land has the necessary infrastructures that may be used to develop later, which will add up their expenses.
B. Risks of Construction loans Mortgages
The ills associated with construction mortgages include project delays and cost overruns. With a prolonged construction period, you make more interest-only payments while the build is still incomplete. A large number of unexpected issues with contractors, building materials, or permits thus drive costs up.
A good general contractor and clear construction plan can always mitigate whatever risk that occurs. It also leads to maintaining a budget for surprise fund expenditures.
The Role of Credit Unions and Alternative Lenders
The Role of Credit Unions and Alternative Lenders: Credit unions and other alternative lenders may serve as useful sources of financing for buyers in need of vacant lands or construction mortgages if there are problems with conventional mortgage providers. Sometimes, credit unions are more flexible as far as terms, and their interest rate is slightly lower because of the member-oriented approach. However alternative lenders can provide personalized services to persons who may have a non-traditional financial situation or are purchasing in rural areas where the typical lenders might not be very willing to finance. Borrowers would do well to remember that these lenders can demand different down payments, terms on loans, and interest rates.
Conclusion
To sum up, whether to opt for a vacant land mortgage or a construction mortgage is simply determined by personal goals and plans. A vacant land mortgage would be the right way to go if you have bought the land with the plan to use it in the future or as an investment. A construction mortgage will work best when you have already planned and are ready to begin building your dream home or embarking on some restructurings.
It is only after one has made his or her decision that he or she will consider all those factors: financial situation, land development potential, and construction plans. Shelto Mortgage will guide you through the complexities of vacant land mortgages and building mortgages to ensure you get the correct choice for your property needs.