How Do Construction-To-Permanent Loans Work?
What You Should Know
- Construction to permanent loans qualify you for two loans at once.
- It bundles a construction and regular mortgage together.
- When the construction is done, the mortgage will roll into a regular mortgage.
- It saves you closing costs but you may have a higher interest rate.
Construction to permanent loans are a type of mortgage that finances the cost of building a home. Once construction is complete, the loan is then rolled into a mortgage. This can be a more affordable way to finance your new home, as it allows you to avoid paying two sets of closing costs.
The primary benefits of construction to permanent loans are avoiding additional closing costs and a fixed interest rate. However, there are rigid qualification criteria, and you must pass milestones to receive additional funding. Continue reading to learn everything about construction-to-permanent loans.
How Does a Construction to Permanent Loan Work?
Construction to permanent loans, also called "single close" loans, finance the construction of your home and are then converted into a regular mortgage once construction is complete. As a result, you avoid paying for two separate mortgage closings. However, the interest rates will likely be higher than financing each separately. This is due to increased lender risk. There are a few uses for a construction-to-permanent loan:
| Scenario | Usage |
|---|---|
| Building a new home from scratch | Finance the land purchase, construction costs, and any permanent improvements such as driveways or landscaping. |
| Already own land | Finance just the construction costs. |
| Own existing home and land | Finance major home improvements ; such as renovations or additions. |
Construction to permanent loans are generally available for single-family homes, but some lenders will extend them to multi-family properties such as duplexes or triplexes. Typically, lenders require a 20% down payment. However, some may require a 25% to 30% down payment. Overall, a construction to permanent loan is the combination of two separate loans.
Part A: Construction Loan
The maximum loan term for construction loans are typically one year. If the construction exceeds this time, you will likely need to pay extension fees. Your lender will also pay the builder in installments as progress is made.
These installments are known as draws and are paid out with pre-determined milestones. For example, the milestones could include setting a foundation, creating a frame, installing roofing, and more. An inspector will verify each milestone on behalf of your lender, who will then provide another draw.
During this phase, your payments will be interest-only. With each draw, your payment size will increase. Depending on your lender, it will either be a fixed or adjustable rate. Once construction is complete and you have a final certificate of occupancy, the loan will be converted into a regular mortgage, such as a conventional loan.
Part B: Regular Mortgage
At this point, you will have reached the end of the construction loan and be ready to enter into a regular mortgage. All the milestones have been accomplished and draws complete. Once you have received a certificate of occupancy, your lender will transfer your construction loan balance to a permanent loan. You can use a construction loan calculator to estimate this amount.
Here you can choose between a fixed or adjustable rate mortgage.
- Fixed interest rate: your mortgage payments would remain the same during the life of your loan.
- Adjustable-rate: Your interest rate and mortgage payment will adjust with the prime rate.
The length of time you have to repay the mortgage can vary. The most common repayment periods are 15 or 30 year mortgages. Some lenders may also offer a 40-year repayment period.
Qualifying For A Construction-To-Permanent Loan
Qualifying for a construction-to-permanent loan is similar to qualifying for a regular mortgage, although there are some additional requirements.
Personal Requirements
You'll need a good credit score (usually at least 620) and a steady income. Lenders will assess your income using your debt-to-income (DTI) ratio. You may also be required to have a higher down payment than you would for a regular mortgage, typically 20% to 30%.
Your lender will also want evidence that you have the ability to complete the construction project. This could include reserve funds.
Property Requirements
The property you're buying, or building must also meet specific standards to qualify for the loan. The home must be a primary or secondary residence in an eligible area. In addition, the property's appraised value must meet or exceed the loan amount.
Your lender may also require additional documentation, such as:
- Complete building plans and specifications
- A signed contract with a licensed general contractor
- Proof of property insurance coverage
| Advantages | Disadvantages |
|---|---|
|
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Overall, construction-to-permanent loans can be a good option if you're planning to build a new home or finance significant renovations. But it's important to compare your options and shop for the best deal before applying.
Construction to Permanent Loan Rates
Construction to permanent loans tend to have higher interest rates than standalone construction loans. The interest rates tend to be 5% higher than market mortgage rates. Lenders see construction-to-permanent loans as riskier because of a more extended payback period.
Depending on your lender, your loan could have a fixed or adjustable rate. With a fixed-rate loan, your mortgage interest rate will stay the same throughout the life of your loan. An adjustable-rate construction to permanent loan may have a lower interest rate during construction and for a set period after construction is complete. After that, the interest rate could rise or fall depending on the federal reserve rate.
Construction to Permanent Lenders
You should compare offers from multiple lenders to get the best construction to permanent loan rates. This section will deconstruct the loan programs offered by different leaders to help you find the best offer. Be sure to compare interest rates, fees, and terms before you apply for a loan. Both rates and fees are included in the annual percentage rate (APR).
| Minimum Down Payment | Construction Phase Payments | Interesting Features | |
|---|---|---|---|
| 20% | Interest Only | Reputable lender | |
| N/A | Interest Only | "Float down" fixed interest rate | |
| No Payments | Most flexible option | |
| Below 20% (with PMI) | Interest Only | Ability for less than 20% down payment | |
| 15% | Interest Only | Online-based application |
TD Bank
With a TD Bank construction-to-permanent loan, you can finance up to 80% of the cost of your home. This includes the cost of land, construction materials, and labor.
The program provides the option for fixed or adjustable rates. You will also need to make interest payments during the construction phase. At the end of construction, the loan converts to a fixed-rate mortgage.
TD Bank will not offer construction financing for co-operative apartments. Additionally, VA or FHA construction loans are not eligible.
Truist
Truist was formed in 2019 after the successful merger of BB&T and SunTrust. Although not many specifics about their construction to permanent mortgage are offered, an idea can be determined through an old SunTrust C2P Mortgage webpage.
Before the merger, SunTrust offered many interest rate options. These include a fixed, adjustable rate, and a fixed rate with the opportunity to adjust down. The final option means you can re-lock the interest rate if market rates decrease.
The construction phase is interest-only, and you'll only need to pay closing costs once. You will need a reputable builder, a signed building contract, a down payment, and a land survey to qualify
No details are mentioned about the minimum down payment requirements.
BuildBuyRefi
BuildBuyRefi offers a one-time close construction mortgage. The program is eligible to combine with VA and FHA Loans. This means you can qualify with a 0% or a 3.5% down payment. However, you must be a veteran or willing to accept the limitations of an FHA loan.
Interestingly, there are no required payments from the borrower during the construction phase. This is a significant difference from most lenders who require interest-only payments. Afterward, you can choose a 15 or 30-year fixed rate mortgage.
First National
First National Bank provides a one-close construction loan program. This loan allows you to make down payments below 20% with private mortgage insurance (PMI). It can also be used for primary or secondary residences.
The construction loan phase lasts 12 months; afterward, the loan converts to a regular mortgage. Additionally, the construction phase requires interest payments.
Normandy
Normandy is an online lender. While they are focused on homes of one to four units, they also have a commercial construction program. Their hiring a builder program requires a minimum 15% down payment.
The construction phase is a 12-month loan by default, although extensions are available. You will only need to pay the interest portion during the construction phase.
Construction-to-Permanent Loan Alternatives
FHA Construction to Permanent Loan
This is a non-conventional loan program offered by the federal government. An FHA loan can be beneficial if you have a low credit score or don't have enough money saved up for a down payment. With an FHA construction-to-permanent loan, your loan amount will be based on the home's value after completion. The maximum loan amount is typically 96.5% of the home's appraised value.
You can also use an FHA construction-to-permanent loan to finance major renovations or additions. In this case, you would need to have an architect's plans and a signed contract with a licensed contractor.
Construction-to-Permanent Loan vs. Stand-Alone Construction Loan
Another option for financing your new home is a standalone construction loan. This option is best if you plan to sell the house before construction ends. With this type of loan, you finance the cost of construction with a short-term loan.
However, you still have the option to refinance into a permanent mortgage when the project is complete. Although if you choose to refinance into a permanent mortgage, you'll have to go through the mortgage underwriting process twice.
You may also have to pay two closing costs with a standalone construction loan. If you want to use money from a family member or friend as a down payment, you may need to get a gift letter notarized.
A benefit is that you may receive a lower interest rate on each loan instead of the combined package. Standalone construction loans can be a good option if you may want to sell your home but still want the option to keep it.
Construction Loans vs. Home Equity Loans
Another way to finance the cost of your new home is with a home equity loan. With this type of loan, you use the equity in your current home as collateral. As such, this method is best used to build a secondary residence.
A construction loan is a good option if you don't have equity in your current home or if you plan to sell your existing home when construction is complete. However, a home equity loan can be a good option if you have equity.
With a home equity loan, you'll need to go through the mortgage application process, and you may have to pay for an appraisal and title insurance. You'll also need enough equity in your current home to qualify for the loan.
A home equity loan is an excellent option if you have sufficient home equity. Some options, such as a home equity line of credit (HELOC), have a ten-year interest-only period. This allows you to make minimum payments while you build the home and refinance into a conventional mortgage later.
Additionally, HELOCs tend to have lower interest than construction loans. Since you are lending to yourself, there will be no required inspections to receive draws.
Frequently Asked Questions
A construction to permanent loan is a good option when you want to avoid paying two sets of closing costs. It can also be good if you receive a fixed rate. This will protect you from any increases to the prime rate while you build.
It depends on several factors, such as where you live, the current market conditions, and how much work you're willing to do yourself. Generally, it's cheaper to build a home than to buy one. However, building a home comes with increased risk. You will likely need to pay the difference if your project runs over budget.
When you apply for a construction-to-permanent loan, you'll need to provide more information than when you apply for a mortgage. For example, you'll need to provide detailed plans and specs for your home. You'll also need to show that you have the funds to cover the construction cost.
Your lender will also want to see a letter from your contractor stating that they expect to complete construction on schedule and within budget. This letter should also include the projected start and finish dates for construction.
Lenders are stricter with construction-to-permanent loans because they're seen as riskier. You may need a higher credit score and down payment to qualify.
With a construction loan, your builder is paid as they complete specific milestones in the construction process. However, you will likely need to make an up-front deposit to cover the initial building materials.
Afterward, your lender will pay directly to your builder with each accomplished milestone. The pre-determined milestones may include laying the foundation, creating the frame, internal plumbing, etc. If the builder overshoots the budget, you will likely need to make the difference.
You will typically need to pay interest only on the funds you have drawn from your construction-to-permanent loan. With each daw, your required interest payment will increase. Your mortgage balance will be rolled into a mortgage loan at the end of construction. You will then need to make monthly payments of principal and interest.