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If you’re building a new home a construction loan is essential for financing the building process. But once construction is complete you’ll need to convert the construction loan into permanent financing with a mortgage. This process is known as converting a construction loan to a mortgage.
I’ll walk through everything you need to know about converting construction financing to a mortgage including
- What is a construction loan?
- How construction loans work
- When to convert a construction loan to a mortgage
- The construction loan conversion process
- Tips for converting a construction loan
What is a Construction Loan?
A construction loan is a short-term loan used to finance the building of a new home. It covers costs like land, materials, labor, permits, and more during the construction phase.
Construction loans come in a few forms:
- Construction-only loan – Finances just construction. A separate mortgage is needed after building.
- Construction-to-permanent loan – Converts to a mortgage after construction.
- Renovation loan – Finances renovations and repairs to an existing home.
With a construction loan, funds are disbursed in installments as certain milestones are met during the build. An inspector verifies progress before each disbursement.
How Do Construction Loans Work?
Construction loans have two phases – the construction phase and the conversion phase:
Construction Phase
This is when the home is built over months or up to a year. During construction:
- Loan proceeds pay for land, materials, labor as needed
- An inspector approves each draw request before funds are released
- You only pay interest on the loan during this phase
- Loan amount is based on the home’s estimated value when complete
Conversion Phase
Once construction is finished, the loan converts to a mortgage:
- Remaining loan balance becomes the mortgage principal
- Loan transitions to a traditional 15 or 30-year mortgage
- You begin making principal and interest payments
When to Convert a Construction Loan
The construction phase typically lasts 6-12 months but can vary. A certificate of occupancy from the city is required before converting to a mortgage.
Your loan officer will guide you on timing. But in general, you should convert the loan as soon as possible once construction is 100% finished.
Benefits of converting quickly:
- Start building equity sooner
- Lock in lower interest rates
- Begin deducting mortgage interest on taxes
The Construction Loan Conversion Process
Converting a construction loan to a mortgage involves several steps:
1. Final inspection
- An appraiser will complete a final inspection to ensure the home is fully built to specifications.
2. Obtain certificate of occupancy
- This certifies the home meets building codes and is safe to occupy.
3. Conversion paperwork
- You’ll sign new loan documents to convert the construction loan to a mortgage.
4. Pay closing costs
- As with a normal mortgage, you’ll pay various fees like title insurance, recording fees, etc. However, costs are lower than purchasing a separate mortgage since you already financed the home’s construction.
Once those steps are complete, your mortgage payments will begin on the remaining balance.
Tips for Converting a Construction Loan
Follow these tips to make the construction loan conversion process smooth:
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Communicate with your lender – Let them know when construction seems to be nearing completion.
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Get inspections done ASAP – Schedule the final inspection and certificate of occupancy as soon as construction is done.
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Have funds ready – Save up to pay closing costs and your first mortgage payment.
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Understand your options – Talk to your lender about mortgage term lengths and rate options when converting.
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Lock your rate – Rates fluctuate frequently. Lock in your rate so it doesn’t rise before converting.
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Review closing documents – Read documents carefully to avoid surprises at closing.
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Consider timeline – Try to close before your construction loan’s term expires to avoid extensions.
What is a construction-to-permanent loan?
A construction-to-permanent loan — also known as a one-time, single-close or construction-perm loan — is a type of mortgage for those building a home. It funds the purchase of land and the home’s construction. Once the home is built, the loan converts into a traditional mortgage, usually with a 15- or 30-year term.
Conventional construction-to-permanent loans can have fewer restrictions than government-backed loans.
Pros and cons of construction-to-permanent loans
Construction-to-permanent loans have benefits as well as drawbacks. Here are the major ones to consider.
Use A Construction Loan To Build A House?
FAQ
What happens at the end of a construction loan?
What is the primary disadvantage of a construction permanent loan?
What is a permanent loan taken out after the construction loan?
Is a construction loan more expensive than a mortgage?
How does a construction mortgage work?
During the build phase of a construction mortgage, the payments are interest-only. Then, you settle your balance as you roll the principal into your 30-year, fixed-rate mortgage. Construction-to-permanent loans are a common type of real estate loan, which combines the build and mortgage loans into one 30-year loan at a fixed rate.
Can a construction loan be converted to a mortgage?
In some cases, a construction loan can be converted into a traditional mortgage to continue paying off your new home. If not, you may need to take out a new mortgage to continue paying it off. Your construction loan can be converted to a mortgage in some instances.
What is a construction-to-permanent mortgage?
A construction-to-permanent mortgage is a loan for building a new home, which converts into a traditional mortgage once the home is built. The loan usually has a 15- or 30-year term.
How does a construction home loan work?
A construction home loan is a short-term, adjustable-rate loan issued by a lender that is used to complete construction of a home. After construction is complete, the loan must be paid in full or refinanced into a mortgage. This requires two application processes and two closings. Draws are made to the owner-builder, rather than to an approved third-party contractor.