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Due to rising mortgage rates and falling home prices, some pre-construction home buyers are facing financing issues. Let’s look at their options.
Many Canadians bought pre-construction homes and condos at the height of the real estate market, as ultra-low interest rates fuelled a steady climb in Canadian real estate prices. Now some of those buyers are walking away from their purchases, unable to close on properties worth less than they paid for them. These buyers risk losing deposits worth $100,000 or more—sometimes, much more.
What are your options if you find yourself in this situation? Let’s look at the intricacies of buying a pre-construction home in Canada, why some buyers are having difficulty closing on their purchases, and steps you can take to avoid losing a large deposit.
Generally, pre-construction homes offer several key benefits. For one, the property is brand new. Unlike with a resale home, you can customize a new home right down to the finishes and countertops. And because the home is new, you can expect to spend a lot less on repairs and maintenance.
New homes also give you more time to save. With resale homes, you typically must pay the deposit and down payment within a 30-to-90-day timespan. With new homes, the deposit can often be spread over several months or years.
In case you’re new to buying pre-construction homes in Canada or you’d like a refresher, here are some important details to be aware of.
Unlike a resale home when you usually pay the deposit within 24 hours of your offer being accepted, with a pre-construction home there’s typically a deposit payment schedule.
With a pre-construction home, you’re usually expected to have a down payment of between 20% and 25%. This may sound like a lot at first, but the amounts are spread over several months and years. For example, you may be asked to make a deposit of $3,000 at the time of making an offer, followed by 5% within 30 days of the offer, 5% within 90 days, 5% within 180 days and a final 5% at the time of occupancy.
Oftentimes, the deposit structure is up for negotiation. If the builder’s payment schedule doesn’t work for you, you should try to negotiate one that does.
In Canada, mortgage rules are the same for a new home as a resale home. For example, you’re required to pass the mortgage stress test in both cases. However, a key difference is timing. With a new home, you don’t know what mortgage rates will be when the property closes. Mortgage rates could be the same, or they could be higher or lower. This adds uncertainty. Without knowing what mortgage rates will be, you actually don’t know if you’ll be able to afford the property in the future.
There’s also the issue of the property value for mortgage lending purposes. Lenders don’t sign off on the mortgage for a pre-construction home until the time of closing. You make an offer without financing, then hope to get financing at the time of closing.
The issue is that most lenders offer a mortgage based on the lesser of the purchase price and the appraised value. The purchase price is known. It’s what you paid for your pre-construction home as agreed to in the contract you signed with the builder. The appraised value is unknown at the time of purchase when you sign the contract. The lender doesn’t typically do the appraisal until the pre-construction home is 97% complete (only the landscaping and other finishing touches are left to do). That could be in two to three years or more, depending on how long it takes to build. Property values can shift a lot during that time.
Let’s look at why Canadians are walking away from their new homes right now.
Mortgage rates are playing a big role in Canada’s real estate market. Nobody anticipated that fixed mortgage rates and variable mortgage rates would have risen as quickly as they did throughout 2022 and 2023, but here we are.
With a pre-construction home, you can’t choose the final closing date. You’re at the mercy of the builder. The builder lets you know the expected closing date when you sign the purchase contract, but there can always be unexpected delays that can push back the original timeframe. The builder has to give you sufficient notice, but that can still mean closing on your pre-construction home later than you anticipated or wanted to.
When you initially bought your pre-construction home, you might have done so assuming that mortgage rates would be similar to current rates or lower at closing. This could cause you to reconsider your purchase and look for a way out.
The biggest driver of home prices in Canada are interest rates. Higher interest rates have led to home prices remaining flat and falling in many cases. Depending on when you purchased, your pre-construction home may no longer be worth what you paid for it. Since you agreed to the purchase price when you first bought it several months or years ago, your new home may be worth less today. This can lead to huge problems.
Let’s say you agreed to purchase a new home for $700,000, but it’s only being appraised by your lender at $650,000. That means you’re short $50,000, an amount you must cover yourself. Many purchasers can’t, which is why some are reconsidering their home purchase. In extreme cases, buyers are finding themselves with a shortfall of $100,000 or more.
Here are some things you can do if you find yourself in this situation.
Getting a co-signer or co-buyer is one option. Whether it’s a family member or friend, if someone you know and trust is willing to help you make up the shortfall, you might still be able to close on the property. Just make sure that everyone involved consults with a real estate lawyer so that everyone knows the rights and obligations that come with co-signing.
If co-signing is won’t work, consider working with an alternative or private lender. You can access alternative lenders through mortgage brokers. Alternative and private lenders are a lot more flexible than the big banks and may be willing to value your property based on the higher purchase price instead of the appraised value, but their mortgages often come with a higher rate and fees.
A third option is to assign or sell your pre-construction home before the closing date. This is known as an assignment sale. You may be selling the home at a loss, but at least you can limit your legal exposure. You’ll want to work with a good real estate lawyer. An assignment sale means losing part or most of your deposit, but it can offer some legal protection if the builder is forced to sell at a loss and takes you to court. In most cases, an assignment sale should be your last resort.
Before walking away from your deposit, it’s important to consider your options. As you can see, there are several available.
Before buying a pre-construction home, it’s important to be aware of the potential risks. New homes have several benefits, but failing to have a backup plan can cause yourself a lot of worry and stress for nothing. By planning ahead, you can help mitigate your risks and have a pleasant new home buying experience.
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