The Construction Mortgage: How It Works, Key Steps and Practical Tips

In this article

• What is a construction mortgage?
• How does a construction mortgage work?
• The steps involved in a construction mortgage
• Practical tips for planning your financing
• In summary

How does a construction loan work?

Progressive disbursements based on construction progress

The principle is simple: the financial institution releases funds as construction progresses.

Depending on the lender, financing may include three or more disbursements. Common milestones include:

• Completed and backfilled foundations
• Building enclosure, with exterior finishes and interior walls sufficiently advanced
• Completion of construction

For a custom home project, we generally recommend planning for five or six disbursements when the financial institution allows it. More frequent disbursements can make cash flow easier to manage and better align with the payment schedule outlined in the construction contract.

Terms vary from one lender to another. Some allow additional disbursements at no extra cost, while others may charge additional inspection fees. It is therefore important to discuss this structure with your financial institution before construction begins.

The value of the land can be used toward the down payment

When the homeowner already owns the land, its equity can generally be taken into account as part of the financing structure.

Every homeowner’s situation is different, so the financing structure should be established with the lender or mortgage broker.

Inspections determine when funds are disbursed

Before each disbursement, the financial institution must verify the progress of construction to confirm that the value of the building corresponds to the expected percentage of completion.

The homeowner must therefore closely monitor construction progress and request inspections at the appropriate time.

You should also account for the time between requesting an inspection and receiving the funds. Depending on the financial institution and the time of year, the process can take anywhere from a few days to approximately 10 days. Careful planning is therefore essential to prevent a disbursement from arriving after a payment to the contractor is due.

A portion of the funds will be held back until the end of the project

Financial institutions require a holdback on disbursements to protect themselves against risks such as legal construction hypothecs.

A 15% holdback is common, although the exact terms vary depending on the lender and type of financing. The funds being held back are released after construction is completed and once the financial institution’s requirements have been met.

It is therefore important to understand from the outset how much money will actually be available at each stage of construction.

During construction, you generally pay interest on the amounts already disbursed

During the construction period, interest is calculated on the amounts that have already been released rather than on the full amount of approved financing.

Once the home is completed and the financing is converted, regular mortgage payments begin according to the terms agreed upon with the lender.

Plan for financial flexibility

One of the most important things to understand is that the mortgage disbursement schedule does not necessarily align with the contractor’s payment schedule.

These two aspects must therefore be planned together.

It is essential to have additional funds available to meet the payment deadlines in the construction contract while waiting for the next mortgage disbursement.

You should also plan for contingencies, unexpected expenses, choices that evolve during the project and upgrades requested during construction. A reserve of 10% to 15% of the project cost is generally a prudent margin, depending on the nature of the project and what is already included in the contract.

You must also account for the amounts that will be held back by the financial institution.

In some cases, a line of credit, temporary loan or bridge loan can help manage this transition period. However, the financing structure should be established with the professional assisting you with your financing.

Funds required before the first disbursements

At Écohabitations Boréales, a 5% deposit is required when the contract is signed, followed by 10% when orders are placed.

This means that 15% of the project cost, before management fees and taxes, must be available before construction begins.

These deposits provide the working capital required to launch and maintain the project. They are declared and protected under the GCR warranty plan.

2. Prepare a strong financing application

Obtaining a construction mortgage requires a more detailed application than a standard mortgage pre-approval.

The lender will want to assess your financial situation, the land, plans and specifications, construction budget, projected value of the home and the contractor’s estimate. The anticipated construction schedule may also be part of the application.

For a custom home, working with an experienced construction company such as Écohabitations Boréales allows you to present a well-structured project with a detailed estimate and a clear understanding of the costs associated with each stage.

Our experience in custom home construction and our relationships with various financing professionals can also facilitate communication between the client, lender and construction team.

3. Finalize financing before construction begins

Once the application has been approved, the financing terms are finalized and the documents are prepared for signing before a notary.

Before construction begins, it is important to clearly understand:

• The number of planned disbursements
• Inspection timelines
• Amounts that will be held back
• The cash required between disbursements
• Costs that are not covered by the mortgage or the contractor’s agreement

Understanding these aspects of your financing helps prevent unpleasant surprises once construction is underway.

4. Manage disbursements during construction

Once financing is in place, construction can begin.

Coordination between construction progress, inspections and the release of funds then becomes essential. Requesting an inspection too early or too late can create a gap between payments due to the contractor and the funds available.

At Écohabitations Boréales, we are accustomed to working with this type of financing structure and can help our clients plan the different disbursement stages.

5. Convert the loan into a traditional mortgage

At the end of construction, once the financial institution’s requirements have been met, the construction loan is converted into traditional mortgage financing.

Regular payments are then established according to the loan terms negotiated with your financial institution.

Practical tips for planning your financing

Understand what is included in the estimates

The cost of a home does not necessarily represent all expenses associated with the project.

Items such as permits, soil testing, certain excavation and landscaping work, utility connections or technical adjustments related to the lot may be added to the construction cost. Whether these items are included varies depending on the project and contractor.

At Écohabitations Boréales, we provide a detailed construction estimate outlining budget allowances for items such as plumbing, cabinetry and foundations, along with the project’s inclusions and exclusions.

The earlier these elements are clarified, the more accurately the financing structure can reflect the actual project.

Let the project and financing evolve together

With a custom home, decisions naturally evolve throughout the design process and even during construction. The financing must be able to evolve along with them.

Developing the design, cost estimate and financial plan in parallel helps avoid last-minute adjustments, which are often more expensive and stressful.

This is one of the reasons we recommend involving our team from the earliest stages of the project. By reviewing and adjusting the estimate with the client and designer, it becomes easier to find the right balance between the project vision and the available budget.

Track the actual cost of the project as it evolves

Between the initial budget and the completion of a custom home, many decisions can affect the project cost, including material selections, modifications, additions, savings in certain areas and unexpected expenses.

To give our clients a clear picture of their financial position, Écohabitations Boréales updates the project’s detailed budget every 6 to 8 weeks.

This process provides a clear breakdown of:

• Amounts already paid
• Committed or incurred costs
• Expenses still to come
• Cost increases and savings resulting from changes to the project
• The impact of these changes on the home’s projected total cost

This allows clients to understand not only where the project currently stands, but also where it is heading financially.

This tracking tool helps clients make more informed decisions during construction and adjust certain choices when necessary rather than discovering the difference between the initial budget and final cost at the end of the project.

For a custom home, where decisions naturally evolve throughout construction, this level of visibility is a valuable management tool and an important part of maintaining control over the budget.

Understand the particularities of building on your own land

Écohabitations Boréales exclusively builds homes on land already owned by its clients.

Even when the homeowner is not personally carrying out the construction work, some financial institutions may still classify this type of project as an owner-builder project.

In this situation, mortgage disbursements are made directly to the homeowner, who then uses the funds to pay the contractor and other eligible project expenses.