If you’ve taken out a construction loan to build your dream home from the ground up, you may be wondering what comes next once the construction is complete. Many construction loans are designed to be temporary financing that you pay back or refinance into a permanent mortgage loan when the house is built. Refinancing into a mortgage can help secure long-term financing and lock in a favorable interest rate.
In this comprehensive guide, we’ll walk through everything you need to know about refinancing a construction loan, including:
- How construction loans work
- Different types of construction loans
- When to refinance a construction loan
- Tips for getting the best mortgage rates
- How to choose the right lender
Let’s get started!
How Do Construction Loans Work?
Before diving into refinancing, it helps to understand what construction loans are and how they operate.
Construction loans provide short-term financing to fund the building of a new home Unlike a traditional 30-year mortgage, construction loans are paid back within 1-2 years after the home is completed
These loans carry more risk for lenders since the home doesn’t exist yet as collateral As a result, construction loans typically require a 20-25% down payment and a higher credit score compared to a conventional mortgage
The loan is disbursed to the borrower in installments or “draws” at certain milestones during the building process to cover construction costs. Once the home is finished, the construction loan must be repaid in full or refinanced into a permanent mortgage.
Types of Construction Loans
There are several types of construction loans, each with their own process for refinancing:
Construction-to-Permanent Loans – These combine the construction loan and mortgage into one loan with the same lender. Apart from the interest rate, most terms are set upfront. Once construction is done, the loan automatically converts to a permanent mortgage at current market rates.
Construction-Only Loans – This short-term financing covers just construction costs. It must be paid back or refinanced into a separate mortgage once the home is complete.
Owner-Builder Loans – For borrowers acting as their own contractor. A building inspector certifies each stage of construction before draws are released.
Renovation Loans – Used to repair or remodel existing homes. If a contractor is hired, it works like a standard construction loan. If doing it yourself, it operates like an owner-builder loan.
Government-Backed Loans – FHA, VA and USDA loans help certain borrowers finance construction. These can be structured as construction-to-permanent or construction-only.
When To Refinance a Construction Loan
For construction-only loans, you’ll need to refinance into a mortgage as soon as the home is finished. Construction-to-permanent loans automatically convert to a mortgage loan once the build is complete.
Most construction loans charge higher interest rates than conventional mortgages, so refinancing makes sense to lock in a lower long-term rate. Refinancing also allows you to pay off the construction loan and set up traditional mortgage financing.
Aim to start the refinancing process 60-90 days before construction is scheduled to be completed. This gives you time to shop around, compare mortgage rates, and choose a lender.
Many experts advise having a rate lock in place to guarantee your interest rate before construction is fully finished. This protects you from any rate increases during the gap between construction ending and refinancing.
Tips for Getting the Best Mortgage Rates
Follow these tips when refinancing a construction loan to score the lowest mortgage rate possible:
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Check your credit score – Maintaining a high credit score in the 680+ range can mean better mortgage rates. Avoid taking on new debt during the building phase.
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Compare multiple lenders – Look at rates and fees from national banks, local banks, credit unions, and online lenders. Get pre-approved with several for the best deal.
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Consider points – Paying points upfront can lower your interest rate.Calculate if it makes sense based on how long you plan to stay in the home.
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Lock your rate – Lock in a rate 60-90 days before construction is complete to hedge against increases. Many lenders offer free rate locks.
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Review closing costs – Closing costs can vary widely between lenders. Factor them in when comparing loan estimates.
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Negotiate – Try negotiating with lenders to remove overlays, reduce fees or beat a competitor’s rate. Having competing offers can help.
How to Choose the Right Refinancing Lender
Finding the ideal lender for refinancing takes research and comparison shopping. Here are some factors to consider:
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Interest rates and fees – Compare quotes from multiple lenders. Look for the overall lowest costs.
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Loan types – Not all lenders offer every type of loan. Find one that provides the mortgage program you want.
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Reputation and reviews – Read reviews and complaints to gauge customer satisfaction. Check their BBB rating.
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Customer service – A responsive loan officer who communicates well makes a big difference.
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Loan process – Look for an efficient approval process and quick closing timelines.
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Availability – If choosing an online lender, confirm they operate in your state.
Getting construction loan pre-approvals from several different lenders can help you find the right fit. You want a lender that is competitive on rates and closing costs but also provides an excellent borrowing experience.
Refinancing From Specific Construction Loan Types
Let’s take a closer look at what’s involved when refinancing some of the main construction loan categories:
Refinancing a Construction-to-Permanent Loan
Since these loans automatically convert to a mortgage, refinancing with a new lender means paying closing costs twice. Run the numbers to see if the mortgage rate savings exceed the costs.
If staying with the same lender but the new rate is too high, you can try negotiating for a lower one. If that fails, you have the option to refinance with another lender.
Refinancing a Construction-Only Loan
With a construction-only loan, you’ll need to find a new mortgage lender once the home is complete. Treat this the same as applying for a new purchase loan – shop around to compare interest rates and fees across multiple lenders.
Refinancing Government-Backed Loans
For FHA, VA and USDA construction loans, you can refinance with the same agency or a conventional mortgage. Conventional loans have higher credit requirements but no lifetime mortgage insurance premiums.
Refinancing an Owner-Builder Loan
You’ll follow standard refinancing procedures. Make sure to look at rates from multiple lenders to find the best deal on your long term mortgage.
Refinancing a Renovation Loan
A renovation loan refinance works the same as other construction loans. You can stick with your current lender or find a competitor with better rates.
The Bottom Line
Refinancing a construction loan into a permanent mortgage secures long term financing for your new custom home. Shopping around among multiple lenders can help you land the perfect home loan to fit your needs. With a little preparation and research, you can seamlessly transition into your dream home once construction is finished.
Frequency of Entities:
construction loan: 34
refinance: 19
lender: 14
mortgage: 24
interest rate: 10
home: 21
loan: 38
How Do Construction Loans Work?
Unlike standard mortgage loans, which let you pay back the loan over 10 – 30 years, construction loans are short-term loans that must be repaid after construction, which usually takes 1 – 2 years.
Because the home doesn’t exist yet, you can’t use the home as collateral (like you would with a standard mortgage). And because of other variables – like qualifying for permits and keeping builders on schedule – construction loans are considered higher-risk loans. To get one, you’d need a higher credit score than you’d need to qualify for a standard mortgage, and you’d have to make a 20% – 25% down payment.
If you can’t pay the entire loan back after the construction is done, you’ll need to refinance the loan into a standard mortgage loan or “end loan.”
Refinancing from a building loan to an end loan looks a little different for each type of construction loan.
Once construction is completed, a construction-to-permanent loan automatically refinances into a permanent mortgage with the same lender. The loan that financed the construction will convert into a mortgage.
Construction-to-permanent loans operate as one loan – not two separate loans. They’re known as one-time close loans because you submit one loan application for the construction loan and the mortgage loan and attend one closing for both. This cuts down on time and closing costs.
When setting up a construction-to-permanent loan, nearly everything is agreed on at the start, except the mortgage interest rate.
The rate will be adjusted to current market rates when construction is over, and the loan switches over to a mortgage loan. That means the interest rate on your mortgage loan could go up or down.
If the new mortgage interest rate is too high, you don’t have to stay with your lender after the construction loan term ends. You can search for a better rate and refinance with another lender for the end loan.
If you’re planning to refinance a construction-to-permanent loan with a new lender, take closing costs and lender fees into consideration. You’ll end up paying those twice if you switch lenders.
A construction-only loan is a short-term, unsecured loan that only covers the cost of construction. Once construction is completed, the loan has to be fully repaid or refinanced into a permanent mortgage.
While you can convert to an end loan with your existing lender, it’s a good idea to check out other lenders. Treat this stage as though you’re looking for a new loan because, essentially, you are.
Refinancing a construction-only loan to a different lender is simpler than refinancing a construction-to-permanent loan with a new lender because there’s no existing mortgage to exit from. But you’ll still have to put in the work to find a new mortgage lender and renegotiate a new mortgage.
Construction loans are paid out in installments or “draws.” Money is drawn out to cover expenses at different stages of the build.
The federal government backs construction loans through the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA) and the U.S. Department of Agriculture (USDA).
- FHA loans target first-time home buyers or buyers with past credit issues.
- VA loans can help qualified veterans, active duty service members and qualified surviving spouses get financing to build a home.
- USDA loans can help buyers build homes in designated rural areas.
You can take out a government-backed construction-to-permanent loan or a construction-only loan. When it comes to refinancing these loans, you’ve got two options:
- Refinance with the same federal agency: Refinancing through the same agency can help you change the loan type or potentially get a lower interest rate. Some government-backed loans offer streamlined refinancing options that make it easier to refinance your loan.
- Refinance to a conventional mortgage: While conventional mortgages may come with different interest rates and higher credit score requirements, you may benefit from not having to pay for mortgage insurance premiums (MIPs) for the life of the loan.
Owner-builder construction loans can be construction-to-permanent loans, construction-only loans or government-backed loans. And they come with a few unique features.
An owner-builder loan is for the professionally licensed and skilled among us who want to act as their own contractor and oversee construction.
Even if you qualify for the loan, you’ll be expected to work with a building inspector who will certify each construction milestone to trigger a new draw.
Refinancing to an end loan with an owner-builder construction loan is fairly straightforward. You’ll need to compare lenders and look at market interest rates to find the best end loan for you.
Renovation loans are often categorized as construction loans, even though they’re used to renovate or repair an existing home rather than build a new home from the ground up.
Which renovation loan you get will depend on who’s doing the renovations.
If you’re planning to do the renovations yourself, the loan will be similar to an owner-builder loan. If you’re hiring a contractor, it will be similar to the standard construction loans.
You refinance renovation loans the way you would any other loan. Compare your current lender’s interest rates with market interest rates and decide whether it makes sense to refinance with your current lender or to choose a new lender.
Whether you’re refinancing a construction-to-permanent loan, construction-only loan, owner-builder construction loan, renovation loan or government-backed construction loan, be sure to:
- Compare construction loan interest rates from multiple lenders
- Factor in lender fees and closing costs
- Know how much the mortgage insurance premium (MIP) will cost if you’re going to refinance a government-backed loan
- Find out if there are any limits on how much you can borrow against your home equity in the future
Take your time to interview loan officers and review lender estimates before you apply for refinancing.
And be mindful about taking on new debt during the construction phase.
Because the building process may take a while (typically 18 – 24 months), your credit score can change from when you first applied for the construction loan to when you decide to refinance to an end loan.
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For some home buyers, the existing pool of homes doesn’t meet all their wants or needs. Maybe your must-haves require building the home of your dreams from the ground up. Maybe life in the city has lost its shine, and you want to build a home in a quieter area.
It may also be the case that you’ve crunched the numbers and figured out that you could save money building your own home.
But that home won’t build itself or finance itself. You’ll need a new-construction loan or home building loan to cover the cost of buying the land and building the home.
Once construction is done, you’ll probably need to refinance the new-construction loan into a mortgage loan.
The steps you’ll take to refinance the loan will depend on the construction loan you chose. There are five types of loans:
- Construction-to-permanent loans
- Construction-only loans
- Owner-builder construction loans
- Renovation loans
- Government-backed construction loans
But before we dig into each loan type and how to refinance them, let’s dig into how construction loans work.
Use A Construction Loan To Build A House?
FAQ
Is it possible to refinance a construction loan?
Can you convert a construction loan into a mortgage?
Can you refinance while under construction?
How does equity work on a construction loan?
Should you refinance a construction loan?
Refinancing your construction loan is a great strategy to get a lower interest rate on your end loan. Shop around for mortgage rates during the final phases of construction so you’re ready to refinance when the final nail has been hammered and the last screw has been tightened.
What is a renovation construction loan?
Renovation construction loans include the cost of major renovations in the mortgage. The total loan amount is based on the value the home will have once the construction work is done. Is a construction loan harder to get than a traditional mortgage?
Can you get a construction loan for a new home?
Construction loans exist to finance new home construction. Homeowners who want to renovate an existing home have other options, including: Home equity loans: These “second” mortgages tap your current home’s value so you can use it on renovation projects.
Should I get a construction loan or a traditional mortgage?
If you want to build a newly constructed home, rehabilitate a fixer-upper or execute a major renovation on your existing home, then a construction loan is likely the best option. On the other hand, if you’re leaning toward purchasing a new construction home, a traditional mortgage may be your best fit.