When starting the new home construction process under a draw mortgage plan, there are a number of possible setbacks that can crop up over the course of the building year that can cause some serious impediments to the project itself.
Simply because of the heavy involvement of the financing bank in the project, and the risks associated with engaging such a large project as building a new home, a buyer needs to make sure that they have planned in a way that keeps them aware of all the short-fall risks that can impact their purchase. Most importantly, new home builders need to make sure that they are in a position to actually complete the construction of their home, or risk losing access to financing part-way through, and therefore wind up with nothing but a partially completed lot that cannot be lived in.
By far, the greatest risk associated with building a new home is the risk of a ‘shortfall’. Shortfall risk is the risk that a construction project may fall behind in its completion schedule, which means that the project would require additional funds to complete a particular stage of the project. For example, if the process of digging a foundation for a new home build takes a bit longer than initially planned for because of frozen soil, the construction company involved would require additional funds to continue with that particular stage of the project.
That being said, the bank would refuse to forward the next round of financing until it can confirm that the foundation stage of construction. This creates a situation where consumers need to find a way to finance the remaining amount of labor required to complete that particular stage of the project through their own means, or through some unsecured debt that is aside from the mortgage funds, which is particularly difficult while the customer is already carrying the mortgage debt. Unfortunately, this sort of situation leaves many unprepared buyers stuck in a lurch.
The second major risk associated with completing a new home build through a draw mortgage is the risk that the builder does not complete the project stages in accordance to the bank’s specifications, which again will stop the bank from forwarding funds for the next round of the project. Even if the builder completes the stage of the build on time, the bank still requires that the quality of the work meets their standards, and therefore ensures that the integrity of their collateral remains intact. Without approval from the bank inspector, the project will come to a standstill, and the buyer is again stuck in a situation where they need to come up with funds out of pocket to financing the required adjustments.
When looking at how it is that both of these setbacks will result in the buyer being stuck in a situation where they can’t complete their home construction without coming up with funds out of pocket, it is important to look at how it is that we mitigate the risks of the shortfall happening in the first place. By far, the most effective way of preventing this shortfall is to plan ahead in as much detail as possible. Most importantly, a buyer needs to understand what kind of experience they have in building homes, and if they have worked with our financing bank in the past.
Because banks will generally finance hundreds of these deals every year, they will have a good idea of which construction companies are best able to complete the construction phases on time, and which ones have fallen short in the past. Banks will more than happily share this information, because they lose money, and are equally frustrated by a short-fall as the customer, because of the way in which it dramatically increases the risks associated with their loan.