Construction Mortgage in Canada: How Does it Work?

Posted by Dave Kotler on Tuesday, February 25th, 2025 at 10:46am.

Construction loans are specialized financing tools for custom, new build homes. Unlike traditional mortgages, these loans disburse funds incrementally as construction milestones are met, which allows builders to access the necessary capital at each stage of development while minimizing upfront financial risk.

This structured funding approach is crucial for custom home construction because it ensures that money is available to cover the evolving costs of building a home, helps manage cash flow effectively, and provides a clear framework for monitoring progress and ensuring that the project stays on budget. However, they have stricter qualification criteria, including a strong credit score, detailed plans, and a 20%–30% down payment. Are construction mortgages right for you? Here's what you need to know when building a house in Canada.

For informational purposes only. Always consult with a licensed mortgage or home loan professional before proceeding with any real estate transaction.

5 Things to Know About How Construction Loans Work

Construction loans finance new builds or major renovations with funds disbursed incrementally.
Borrowers make interest-only payments on amounts drawn during the construction phase, providing flexibility in payment structures and easing the financial burden while managing ongoing expenses related to building materials and labour.
A minimum down payment of 20% to 30% is typically required.
Funds are released in stages based on construction milestones and inspections.
The mortgage converts to a standard mortgage upon construction completion.

What Is a Construction Mortgage?

A construction mortgage is a specialized loan designed to finance the cost of building a home or renovations and additions to an existing home.

Unlike traditional mortgages, which provide a lump sum of money upfront, construction mortgages are disbursed in stages, also known as “draws.” These draws correspond to specific milestones in the construction process, ensuring that funds are available as needed to keep the project moving forward. This staged disbursement helps manage construction costs effectively and ensures that the project stays on track financially. They must be used to fund the building of a house. These mortgages won't work for manufactured homes or other existing properties.

During construction, you’ll typically make interest-only payments. Interest-only payments are loan payments where the borrower pays only the interest accrued on the drawn loan amount, without reducing the principal balance during a specified period.

Lenders conduct inspections at key construction milestones—such as foundation completion, framing, roofing, and interior finishing—to verify that the work aligns with the approved construction plans and budget. These inspections ensure the project is on schedule and meets quality standards before additional funds are released, protecting both the borrower and lender from financial risk.

Once construction is completed and occupancy is certified, the mortgage will convert to a standard one, requiring regular principal and interest payments.

Eligibility Criteria for a Construction Mortgage

Strong credit score: Typically a minimum of 680, though some lenders may require higher scores.
Stable income: Proof of consistent income through pay stubs, tax returns, or employment verification.
Detailed construction plans: A comprehensive blueprint, project timeline, and cost estimates approved by licensed professionals.
Signed contract with a builder: Agreement with a licensed and insured builder or contractor outlining the project scope and costs.
Substantial down payment: Usually 20%–30% of the total project cost to reduce lender risk.
Proof of land ownership: Documentation that you own the land or are purchasing it with the loan.
Appraisal of projected value: An appraisal based on the expected value of the completed home.
Adequate insurance coverage: Builder’s risk insurance or construction insurance to protect against potential damages during the build.
Low debt-to-income (DTI) ratio: Typically below 43%, though requirements may vary by lender.
Contingency fund: Lenders may require proof of additional savings (10%–15% of the budget) to cover unexpected costs.

Construction Loan Application Process

Lender Consultation

Start with an initial consultation with a lender to discuss your project’s specifics, eligibility, and the estimated cost of building a house. This meeting sets the stage for what you’ll need to provide—such as construction plans, budget, timeline, proof of income, and employment history. These documents will support your application and show your project’s feasibility. Once all documents are ready, submit your application to the lender.

Lender Conducts Appraisal, Risk Assessment & Loan Underwriting

The lender will conduct an appraisal based on the projected value of the completed home and assess the qualifications of your builder. They’ll also evaluate the project's overall risk to ensure the investment aligns with lending policies.

During underwriting, the lender reviews your financial stability, creditworthiness, and the feasibility of your construction plans. This in-depth evaluation ensures the project meets lending criteria and can take several days to weeks, depending on complexity.

Loan Is Approved & Funds Are Released

If the lender approves your application, you’ll receive a commitment letter outlining the loan terms, draw schedule, interest rates, and any conditions that must be met throughout the construction process.

Funds are released incrementally in stages tied to specific construction milestones. Before each draw is disbursed, inspections verify that the project is progressing as planned, ensuring funds are used appropriately.

Stages of Fund Disbursement

Funds are disbursed in structured stages in a construction loan to align with key construction milestones. This method guarantees your financing matches the progress of your construction project. Funds are released through incremental draws, providing you with the necessary capital at various stages without an overwhelming financial burden from the start.

Initial Draw (15%): Released after excavation and foundation work is completed, covering early construction costs.
Second Draw (25%): Disbursed once the framing is complete, including roofing and weatherproofing to secure the structure.
Third Draw (25%): Provided after significant interior work, such as plumbing, electrical wiring, and drywall installation.
Fourth Draw (20%): Released when interior finishes like flooring, cabinetry, and painting are completed.
Final Draw (15%): Disbursed after final inspections confirm the home is ready for occupancy, with all exterior and landscaping work finished.

Managing Construction Costs

Creating a detailed budget is imperative for managing construction costs effectively during the construction phase. Every expense should be accounted for, and a contingency fund of 10-15% should be set aside for unexpected expenses. A realistic budget helps you stay within your financial means and keeps the project moving smoothly.

Monitor your spending regularly against the initial budget to spot potential overruns and make timely adjustments. Hiring a reputable builder with a solid track record is essential; experienced professionals are more likely to adhere to budget and timelines. Communication with contractors and suppliers is also key, helping you maintain transparency and potentially negotiate better rates.

There are ways to save money on a home build at every step in the process, from smart design choices in the planning stage to doing finishing touches DIY after the contract ends.

Utilizing draw loans linked to specific construction milestones can aid in managing cash flow efficiently during the construction phase. This structured approach guarantees funds are disbursed only when needed, preventing overspending. By considering these strategies, you can navigate the complexities of construction financing and keep your project on track financially.

Choosing the Right Lender

Selecting the right lender for your construction mortgage is crucial to the success of your project. Start by comparing construction loan interest rates, as these can vary significantly between lenders. A lower interest rate can save you a substantial amount of money over the life of the loan. Next, consider the loan terms and repayment schedule to ensure they align with your financial goals and project timeline.

Be aware of any fees associated with the loan, such as origination, inspection fees, or bundled home warranty fees, as these can add to your overall costs. Finally, research the lender’s reputation by reading reviews and seeking recommendations. Working with a reputable lender can provide peace of mind and ensure a smoother financing process. By carefully considering these factors, you can choose the right lender and set your construction project up for success.

Construction Loan FAQs

Common Questions About Construction Loans

How Much Down Payment Do You Need for a Construction Loan in British Columbia?

In British Columbia, the down payment for a construction loan typically ranges from 20% to 25% of the total project cost, including land and construction expenses. For example, if you're building a custom home with an estimated total cost of $800,000 (including a $200,000 land purchase), you would need a down payment of at least $160,000 to $200,000. The exact amount depends on the lender’s requirements, your financial profile, and the project's risk level. In some cases, if you already own the land, its equity can be used to help meet the down payment requirement.

Is It Harder to Get a Construction Loan?

Yes, getting a construction loan is generally harder than securing a regular mortgage because lenders view it as a higher-risk loan. Borrowers must meet stricter eligibility criteria, including a higher credit score, a larger down payment, and provide detailed construction plans, budgets, and timelines. Additionally, lenders require inspections at each construction phase to verify progress before releasing funds, making the approval process more complex and time-consuming compared to a traditional mortgage.

What Happens If Go Under Budget When Building Your Home?

If you spend less on building than you borrowed with a construction loan, you simply won’t draw the full loan amount. Since construction loans disburse funds in stages based on completed milestones, you only pay interest on the amount you actually use. Any undrawn funds remain with the lender, and when the project is complete, the loan converts to a mortgage based on the final amount borrowed.

What Happens If You Go Over Budget on Building Your Home?

If you go over budget on a construction loan, you'll need to cover the additional costs out of pocket or secure extra financing. Lenders typically won’t increase the loan amount after approval, as the funds are based on the initial appraisal and project scope. Some borrowers include a contingency fund (usually 10%–15% of the total budget) within their loan to handle unexpected expenses. If the overages are significant, you may need to apply for a loan extension or a separate personal loan, but this can be challenging and may come with higher interest rates or stricter terms.

Do All New Builds Require a Construction Loan?

No, not all new construction homes require a construction loan. If you're buying a newly built home from a builder or developer (often referred to as a spec home), the builder typically finances the construction, and you only need a traditional mortgage to purchase the completed property. However, if you're building a custom home on your own land, especially if you're hiring contractors and managing the construction process, a construction loan is usually necessary to fund the project in stages until it's complete.