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Construction to permanent loans, also known as single-close loans, allow you to finance the construction of a new home as well as convert the loan to a permanent mortgage once construction is complete – all in one loan This loan product eliminates the need to take out separate construction and mortgage loans, streamlining the home building process If you’re looking to build your dream home from the ground up, a construction to permanent loan may be a good option to consider. Let’s take a closer look at how these unique loans work.
What is a Construction to Permanent Loan?
A construction to permanent loan combines two types of loans – a short-term construction loan and a long-term mortgage – into one. It gives you access to funds needed to purchase land and pay for construction costs upfront. Then, once the new home is move-in ready, the loan automatically converts to a fixed-rate permanent mortgage.
With a traditional construction loan, you’d have to apply and close on a separate mortgage after the home is built. Construction to permanent loans let you skip this extra step, completing both financing needs in one loan product from a single lender. The interest rate and terms are set when you first take out the loan.
Construction to permanent loans are offered by banks, credit unions, and mortgage lenders. Loan terms are generally between 15-30 years. They may have higher interest rates than standard mortgages since they carry more risk for lenders.
How Do Construction to Permanent Loans Work?
Here’s an overview of how construction to permanent loans work in 6 steps:
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Get prequalified: Before applying for a construction to permanent loan, get prequalified by a lender to determine the loan amount you can afford.
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Find land to build on: Identify and purchase land to build your new home on if you don’t already own a lot. The lender will want to evaluate the land.
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Provide plans/specs: Give the lender a copy of the final building plans and specs. They’ll want to review project costs.
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Close on the loan: At closing, you’ll sign paperwork and the lender will place funds in an escrow account.
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Draw loan funds: As work is completed, you can make draws from the account to pay builders. Inspections ensure work is done before releasing funds.
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Loan converts: Once construction is done, the loan converts to a fixed-rate mortgage and you begin making principal and interest payments.
During the construction period, you’ll only pay interest on the funds already disbursed to builders. This keeps payments low while your home is being built. The interest rate may also be lower than the permanent rate.
Construction to Permanent Loan Example
Let’s look at an example to illustrate how construction to permanent loans work:
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Mike wants to build a custom home valued at $400,000
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He takes out a construction to permanent loan for $320,000 (80% of value)
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During construction, Mike makes interest-only payments at a rate of 3%
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The builder completes phases of work and Mike draws loan funds to pay them
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Total construction takes 1 year and loan draws equal $300,000
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After the home is finished, the $320,000 loan converts to a mortgage at 5% interest
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Mike now makes principal and interest payments for the remaining 29 years of the loan
Using a construction to permanent loan saved Mike from having to apply for and close on two separate loans. He locks in long-term financing for the full $320,000 upfront.
Pros and Cons of Construction to Permanent Loans
Construction to permanent loans offer several benefits but also have some downsides to consider:
Pros
- One loan for land, construction, and mortgage
- Lock in interest rate upfront
- Streamlined process with one closing
- Only pay interest during construction
- Fixed payments after conversion
Cons
- Higher rates than standard mortgages
- Larger down payments required
- Stricter qualification standards
- Multiple draws can be time consuming
- Cost overruns may require bigger loan
Make sure to weigh the pros and cons before choosing a construction to permanent loan. While they can simplify the process, higher rates and down payments are tradeoffs.
Construction to Permanent Loan Requirements
Here are some common requirements to qualify for a construction to permanent loan:
- Down payment of 10-20% or more
- Minimum credit score around 640
- Debt-to-income ratio below 45%
- Steady income and employment
- Detailed budget and building plans
- Contingency fund for unexpected overages
- Land owned free and clear or purchased with loan
Requirements are stricter than standard mortgages. You’ll likely need a higher credit score and down payment. The lender wants to see you can afford payments even if construction costs end up higher than expected.
How to Get a Construction to Permanent Loan
Follow these steps when applying for a construction to permanent loan:
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Check your finances – Ensure your budget, income, credit score, and down payment amount meet qualification standards.
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Choose a lender – Compare loan terms, rates, and fees from multiple lenders. Local banks and credit unions are good options.
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Submit your application – Provide all required financial, employment, and property documents to the lender.
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Get the land appraised – The lender will assess the land value if you already own it.
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Sign loan documents – You’ll sign the final loan paperwork at closing, then can start drawing funds.
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Make draws – Request disbursements in installments as phases of construction are completed.
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Complete construction – Finish building the home within the timeline outlined in your contract.
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Convert to permanent loan – Once the home is move-in ready, the mortgage portion kicks in.
It’s important to find an experienced lender who has funded these loans before. Ask about their process and timeline so you know what to expect.
Alternatives to Construction to Permanent Loans
If you decide a construction to permanent loan isn’t the right fit, here are a couple alternatives to consider:
Portfolio Loan – This is a permanent mortgage used to purchase land and finance construction. The interest rate adjusts when construction is done.
Two-Closing Loan – You get separate construction and mortgage loans. It requires two loan applications and closing processes.
Compare all options to find the most affordable financing method for building your dream home.
The Bottom Line
Construction to permanent loans can be great for financing a custom built home. You get flexible funding for construction costs upfront, then automatic conversion to a fixed-rate mortgage down the road. Just be prepared for stricter approval standards and potentially higher rates. But in return, you streamline the entire home building process into one loan with one closing. This unique loan product makes building your own home more convenient.
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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.
Let’s Talk Construction to Perm
How does a construction-to-permanent loan work?
Construction-to-permanent loans work in two phases: construction and post-construction. During the construction phase, the lender authorizes payments, or draws, to cover the cost of land, materials, labor, permits, and other expenses. The lender closely works with an inspector to ensure the construction continues on-schedule and on-budget.
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.
Where can I get a construction-to-permanent loan?
You’ll most often find construction-to-permanent loans at banks or lenders that specialize in construction financing. Many types of lenders offer these loans, but they are commonly provided by these institutions.
Can a construction-to-permanent loan be used to finance a condo?
Yes, construction-to-permanent loans can be used to finance condos. No restrictions are associated with tearing down existing structures to rebuild. The loan cannot be delivered to Fannie Mae until the construction is completed and the terms of the construction loan have converted to permanent financing.