Everything You Need to Know About Construct to Perm Loans

A construct to perm loan, also known as a construction-to-permanent loan, is a special type of mortgage that combines construction financing with permanent financing in a single loan This loan product allows borrowers to finance the construction of a new home and then convert the loan to a traditional mortgage once construction is complete, without having to refinance.

Construct to perm loans offer several benefits that make them an attractive option for building a custom home In this comprehensive guide, we’ll explain what construct to perm loans are, how they work, their pros and cons, eligibility requirements, and the process of applying for one.

What is a Construct to Perm Loan?

A construct to perm, or construction-to-permanent loan, is a mortgage product that combines two phases – the construction phase and the permanent financing phase.

During the construction phase, the lender disburses funds on a schedule to the builder to cover construction costs. This phase usually lasts 6-12 months depending on the size of the project. The borrower typically pays interest-only payments during construction.

Once construction is complete and the home is move-in ready, the loan converts to a traditional long-term mortgage, usually for 15 or 30 years. The borrower then begins making principal and interest payments amortized over the remaining term, just like with a conventional mortgage.

The main benefit of a construct to perm loan is that it allows you to secure financing for the construction and permanent mortgage together in one transaction. You don’t have to shop for and close on two separate loans.

How Do Construct to Perm Loans Work?

Construct to perm loans have two distinct phases:

Construction Phase

• After approval, the lender will place the approved loan amount into an escrow account.

• As construction milestones are met, the builder submits a draw request to the lender for payment.

• The lender sends an inspector to verify completion before releasing funds to the builder.

• Draws are made on a preset schedule outlined in the loan documents until the home is complete.

• The borrower usually makes interest-only payments during this phase.

Permanent Financing Phase

• Once the home is completed and approved by the inspector, the loan converts to a fixed-rate permanent mortgage.

• Loan terms are usually 15 or 30 years.

• The borrower begins making principal and interest payments amortized over the remaining term.

• Escrow for taxes and insurance is set up if required.

The interest rate is locked in for the entire term of the loan, providing payment stability once construction is complete.

Construct to Perm Loan Eligibility Requirements

Construct to perm loans have stricter eligibility requirements than conventional mortgages because of the increased risk during construction. Requirements may include:

• Minimum credit score of 680 – 720

• Down payment of at least 20%

• Total debt-to-income ratio below 45%

• Detailed construction plans and specifications

• Licensed general contractor

• Contingency reserve minimum 10% of project costs

• Home appraisal based on expected completed value

The lender will also evaluate the borrower’s financial resources to ensure they can handle the mortgage payments even if the project goes over budget. Meeting these requirements helps mitigate the lender’s risk.

The Pros and Cons of Construct to Perm Loans

Construct to perm loans offer many benefits but also some downsides to consider.

Pros

• One loan for the entire process – more convenient and efficient
• Typically only one set of closing costs
• Interest-only payments during construction make payments more affordable
• Ability to customize the home design and features
• Locked-in interest rate provides payment stability

Cons

• Higher interest rates than conventional mortgages
• Larger down payment required, often 20% minimum
• More stringent credit and income requirements
• Additional fees for draw inspections and administrations
• Cost overruns must be paid out-of-pocket by the borrower
• More complex application process

As with any loan product, you must weigh the pros and cons to determine if it’s the right fit for your situation. The convenience factor is a major benefit for most construct to perm borrowers.

How to Apply for a Construct to Perm Loan

The construct to perm loan process takes more time and coordination than a typical home purchase loan. Here are the basic steps:

1. Choose a contractor – Finding an experienced general contractor is key to completing the project on time and on budget. Provide their credentials to the lender.

2. Find land to build on – You can purchase land outright or if financed, rollover the land loan into the construction loan.

3. Select a lender – Compare offers from lenders familiar with construct to perm lending. Local banks and credit unions are a good option.

4. Submit loan application – You’ll need to provide documents verifying income, assets, credit, construction plans, and permits.

5. Appraisal ordered – The lender will order an appraisal to estimate the completed value of the home.

6. Loan approval – It may take 30-60 days to get approval after submitting a complete application.

7. Close on the loan – At closing, you’ll sign the final loan documents and construction can begin!

It’s critical to choose an experienced lender who can guide you through the unique process. Patience and organization are key to ensure construction goes according to plan.

Construct to Perm Loan FAQs

Can I get a construct to perm loan for a renovation?

No, construct to perm loans are only for building a new home on vacant land. To finance renovations, you would need a different product like a cash-out refinance or home equity loan.

What happens if construction delays extend past the original timeline?

Communicate closely with your lender if delays occur to prevent any issues. The lender may allow extensions if the reasons are justified. If not, significant delays could put you in default.

What if construction goes over the original budget?

Cost overruns are fairly common in construction projects. With a construct to perm loan, the borrower must cover any costs that exceed the loan amount from their own funds, so budget carefully.

Can I lock in my permanent loan rate upfront?

Yes, most lenders allow you to lock in your permanent mortgage rate when your construct to perm loan closes. This avoids payment shock once construction is complete.

Are construct to perm loans more expensive?

Yes, interest rates are typically 0.5 to 1 percentage point higher for construct to perm loans compared to conventional mortgages. You’ll also have additional fees for the draws and inspections.

The Bottom Line

Construct to perm loans allow you to build your dream home from the ground up and provide financing for the land purchase, construction, and long-term mortgage. While the process is more complex than a traditional purchase loan, the convenience of having only one loan makes it an excellent option.

Just be sure to choose an experienced construct to perm lender who can guide you through the process. With proper planning and budgeting, you can make building a custom home more affordable.