Understanding construction mortgages (cost vs value)

Given the numerous construction deals that our office has seen over the past half year, I thought I would provide some details on how construction mortgages work with particular focus on the concept of “cost to complete”.  Banks and lenders use two primary ways to determine their exposure on a construction deal.  One method is referred to as Loan to Value and the other method is referred to as Loan to Cost.  They may sound the same but they are significantly different and can change the entire risk profile of a deal in the eyes of a bank or lender.

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Loan to value versus loan to cost

Quite often we will have a client ask us to help them finance a property that they have been able to purchase for an amount that is less than what the property is worth based on an appraisal. When banks and lenders provide a mortgage to a borrower who is purchasing a property they typically will do so based on the lower of purchase price and value. For example, if a borrower is purchasing a property for $100,000 but has an appraisal showing that it is worth $150,000 a bank or lender will give them a mortgage based on the $100,000 price NOT the $150,000 appraised value. Why? In this example if a 90% mortgage was given to the borrower based on the value, the lender would be giving the borrower $135,000 ($150,000 X 90%). That means a borrower would pocket $35,000 and the mortgage would arguably be more than what the property is worth. Lots of opportunity for mortgage fraud to be committed and banks would be stuck with properties that they cannot sell to recover the mortgage amount. If you would like to ask us about your deal, please email dylan@bridgecap.ca or visit www.bridgecap.ca/dylan