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Financial planning tips

May 06, 2015

How to finance building your retirement dream home

If you dream of leaving city life when you retire and building a house in the country, here’s what you need to know about arranging the financing.

For seven years after my husband and I bought a piece of land in the country, we visited it on weekends, dreaming of the day we'd build our home in this secluded spot beside a small lake. Summers relaxing on the dock, winters snowshoeing the woodland trails — it would be a beautiful country home to share with our two dogs. We'd have a home office for telecommuting now, and we'd retire there someday.

We spent countless hours looking at home plans and home-building magazines over the years we were paying off the property. Then came the time for obtaining permits (which is a whole other story) and financing.

If you're a homeowner, you've probably at one time been involved in arranging a mortgage. But financing a new home build is very different from buying a home from a builder's plans, or buying a resale. Why? Banks won't give you a mortgage for an unbuilt home. So if you don't have the cash available (and how many of us do?), how do you manage it? And how do you keep from carrying a big house debt into retirement?

If you qualify, banks will finance a percentage of your costs through a "progress draw" mortgage. This is financing especially for new builds, wherein the bank releases money in stages (called "draws") as the build progresses. The rate of interest is high, however; in our case, it was more than twice the rate of a standard mortgage when we applied for financing. So what could we do short of taking out a high-cost mortgage for the entire cost?

The key to financing our new home turned out to be the equity in our existing home. While every case is different, here's how we did it, in four steps:

Image of the author Katharine Gebhardt, her husband, Rob, and their two dogs.

The author and her husband, Rob, with their dogs Bella and Jade in their new home (pictured above left as a work in progress).

1. We used our savings

Since dogs are cheaper than children and we had the first but not the second, we had fortunately been able to save up about 15% of the cost of the build, and we started with that. This covered the cost of permits, well, septic system, driveway, and excavation. Be aware of well and septic costs when you're building in the country — they add a lot compared to building in a city or town, and costs vary widely.

2. We drew on the equity in our current home

We set up a home equity line of credit on our mortgage-free home in the city. For a home equity line of credit, the bank provides financing based on your equity – the portion of the value of your home that you own, as opposed to owe. Because it's a line of credit, it's a convenient way to pay bills: You just write a cheque, the way you would on a chequing account. A line of credit has the additional advantage of charging interest on only the amount you've used. This differs from a loan, where the bank provides the entire lump sum up front, and you start paying interest on the full value of the loan right away.

The home equity line of credit requires an appraisal of your home, at your cost. Bear in mind the bank won't necessarily appraise your home at the amount you (or your realtor) think it's worth, and you'll typically get a line of credit for only a percentage of the appraised value. In our case, our bank's maximum was 75% of our existing home's appraised value.

3. We obtained a progress draw mortgage

Once our savings and home equity line of credit were exhausted, we had to turn to a progress draw mortgage — at that higher rate of interest I mentioned earlier. We provided builders' quotes, complete house plans (so the bank could assess the value of the finished house), proof of the property cost and a list of any expenses we expected above the cost of the structure. Let's just say a progress draw mortgage takes way more time to arrange than a car loan, but it has the advantage of being easily converted into a regular mortgage once the house is complete.

Here's how we accessed this money:

  • A progress draw mortgage releases money in installments, called "draws," as you reach milestones in the completion of your home. Our bank offered as many as four draws, but we set up only one. This was partly because for each draw, the bank requires a title search by your lawyer, at your cost. This is to ensure that no new liens have been placed on your property since the last draw. While a title search might only cost around $100 for the average property, ours was among the few left in Ontario that required a very complicated search. Because each of these searches costs almost $1,000, we wanted to minimize draws.
  • Banks have a very specific set of criteria for what must be complete on the house before they'll release each draw. For example, they might release a set percentage once the roof is on, another percentage once drywall is up, etc. Someone from the bank will visit the build site to confirm these criteria have been met, then release the money to your lawyer, minus any percentage your bank requires your lawyer hold back in case liens are discovered on the property. Your lawyer also acts for the bank, so if there is any reason to believe the bank is at any risk, he or she has to tell the bank.

We used our draw first to pay our contractor, then to pay down our line of credit. That didn't save us any money, but it freed up room in our line of credit, which gave us a quick, convenient way to resuming paying the bills.

4. We converted the mortgage

The progress draw mortgage was really to tide us over until we could sell our existing house and pay the bank back. At the end of our build, here's where we stood:

  • The contractor was totally paid.
  • The line of credit was maxed out (remember, we had used the money from the progress draw mortgage to pay down the line of credit once, but it was spent again).
  • We had the progress draw mortgage, at a high rate of interest.

The bank paid another visit to the new house, to ensure it was complete. At that point, we were able to convert the progress draw mortgage into a regular mortgage, at a much lower rate of interest.

Once we sold our house in the city, two months after we moved into the new house, we used the money from the sale to pay off our line of credit, leaving only our regular mortgage to pay.

Sound simple? Trust me, it took a lot of phone calls, many meetings with banks and lawyers, and some unexpected costs, such as multiple title searches and unusually high lawyers' fees — in our case, about $2,500 to get all the i's dotted and t's crossed. Nevertheless, I have great memories of our house build, thanks to an excellent contractor and a husband who kept his eye on the finances at all times. Now we're set to start making more great memories in our dream home in the country.

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