The Complete Guide to Construction to Permanent Loans

Construction to permanent loans, also known as one-time close loans or all-in-one loans, allow borrowers to finance the construction of a new home and automatically convert the construction loan into a permanent mortgage once construction is complete, without having to apply for a separate mortgage This unique type of financing makes building a custom home more accessible and affordable Read on to learn everything you need to know about construction to perm loans and how they work.

What is a Construction to Permanent Loan?

A construction to permanent loan combines a short-term construction loan with a long-term permanent mortgage into one convenient loan product Here’s how it works in two phases

• Construction Phase: The lender finances the building of the home by disbursing funds in increments as construction reaches specified milestones. During this phase, you only pay interest on the amount disbursed.

• Permanent Phase: Once construction is complete and you move into the home, the loan converts into a fixed-rate, fixed-term mortgage and you begin making principal and interest payments.

The main advantage of a construction to permanent loan is that you only go through one loan application, underwriting and closing process. This saves you time and money on origination fees.

Construction to permanent loans are offered by banks, credit unions and specialized construction lenders. Interest rates are typically higher than a conventional mortgage since the lender is taking on more risk.

Construction to Permanent Loan Requirements

Construction loans come with stricter eligibility standards than conventional mortgages. Here are some common requirements:

• Down payment – Expect to put down around 20-25% of the total project costs

• Credit score – Most lenders require a minimum score of 660-680

• Debt-to-income ratio – Your DTI should generally not exceed 43%

• Building plans – You’ll need to submit detailed plans, budgets, permits and licenses

• Proof of funds – Show you have enough cash to cover cost overruns

• Contractor approval – Your builder must be licensed and approved by the lender

Meeting these requirements demonstrates to the lender you are financially qualified to take on a construction project and decreases their risk.

Pros and Cons of Construction to Permanent Loans

Construction to permanent loans offer many benefits but also have some potential drawbacks to consider:

Pros:

• Only one set of closing costs

• Draw funds as construction progresses

• Make interest-only payments during construction

• Lock in your permanent rate upfront

Cons:

• Require a larger down payment

• More complex application process

• Construction delays can increase costs

• Higher rates than conventional mortgages

Overall, construction to permanent loans provide an efficient way to finance a custom built home. But make sure you understand the risks and have sufficient resources in case the project goes over budget.

How to Qualify for a Construction to Permanent Loan

Here are some tips for securing a construction to permanent loan:

• Shop around with multiple lenders to compare rates and fees. Look for construction loan specialists.

• Know the specific loan programs and guidelines for each lender. Requirements can vary.

• Have a sizeable down payment – the more you put down, the better.

• Make sure your income, assets, credit score and debt levels meet the lender’s thresholds.

• Assemble all required documentation like financial statements, permits, plans and budgets. Missing paperwork can delay approval.

• Be ready to cover any cost overruns beyond the loan amount from your own funds. Have a financial buffer.

Taking the time to prepare will set you up for success in getting approved and effectively managing the building process.

What to Expect During the Construction Phase

If you’re approved for a construction to permanent loan, here’s a quick overview of what happens during the construction phase:

• You’ll work hand-in-hand with your lender and their inspectors to facilitate draw disbursements.

• Draws are released incrementally as specific milestones are reached, based on a draw schedule.

• Before each disbursement, the property will be inspected to verify work completion.

• Your lender may hold back 10% of each draw until the end of construction.

• Interest payments on disbursed funds will be due monthly.

• Construction typically takes 6-12 months but delays could impact your rate lock or conversion to permanent financing.

Careful monitoring and open communication between you, the lender and the builder during this stage is crucial to keep the project on track.

Closing Out the Loan and Conversion to Permanent Financing

As you near the end of construction, here’s what you can expect as the loan converts to permanent financing:

• Schedule the final inspection once the home is complete. The inspector will verify all work is finished to plan specifications and up to code.

• Your lender will order an appraisal to determine the home’s as-completed value. This establishes the loan balance for the permanent mortgage.

• Assuming final inspection and appraisal go smoothly, you’ll close out the construction loan and convert it to a fixed-rate permanent mortgage.

• After conversion, you’ll begin making principal and interest payments based on the remaining balance, loan term and interest rate previously locked.

Transitioning to the permanent loan is seamless since you already completed upfront underwriting and the original closing. Enjoy your new home!

Alternatives to Construction to Permanent Loans

Construction to permanent loans have fantastic benefits but aren’t the only financing option for building a home. Here are a few alternatives to consider:

• Construction-only loan – Get short-term financing for the build then apply separately for permanent mortgage after completing construction. Requires two sets of closings.

• Home equity loan – If you have sufficient equity in an existing home, tap it to finance construction of a new home. Can be riskier.

• Renovation loan – FHA 203(k) and other renovation loans allow you to buy and remodel a home with a single loan.

• Owner-builder construction – If you have the skills, you may take on more of the construction yourself to reduce costs.

Compare all your options thoroughly before deciding what works best for your situation.

Frequently Asked Questions

Can I get a construction loan for an existing home remodel?

No, construction to permanent loans can only be used to build a completely new residence. To finance renovations to an existing home, explore renovation loans like the FHA 203(k).

What happens if construction goes past the original timeline?

Communicate frequently with your lender to avoid any issues. Significant delays may mean you have to extend your rate lock period at an additional cost if rates have risen.

How much money should I budget for going over the loan amount?

Industry stats show most construction projects go over budget by 10-20%. Plan for extra contingency funds in this range if possible.

When do I have to move into the new home after construction?

Most lenders require you to move in within 30-60 days of completion to transition to the permanent mortgage. Vacancies after construction could affect your loan.

The Bottom Line

Construction to permanent loans provide home builders with an efficient process for financing a custom built home. By combining construction financing and permanent mortgaging into one loan, borrowers save significantly on time and fees. If you’re planning to build, explore construction to permanent loans as an option that can make owning your dream home more feasible.