Building your dream home is a thrilling journey, but navigating the complexities of financing can feel daunting, particularly for first-timers. If you’re considering building a new home, you’ll want to know about construction-to-permanent loans, which offer a streamlined path to both construction financing and a permanent mortgage.
But how does it work? And how can you avoid common pitfalls, such as cost overruns and multiple loan applications? This guide walks you through each step so you can confidently navigate your homebuilding plans without setbacks.
What are construction-to-permanent loans?
A construction-to-permanent loan pays first for your home’s construction, then transitions into your mortgage once the home is built. Unlike separate loans for building and purchasing, a construction-to-permanent loan covers both phases with a single application, a single closing, and one loan.
The key features of construction-to-permanent financing include:
- One loan: You don’t need to apply for multiple loans throughout the process.
- Single closing: There’s no need for a second set of closing costs or paperwork when construction is complete.
- Construction phase: While construction is underway, you’ll only be required to pay interest on the borrowed amount.
- Permanent mortgage: Once construction is done, the loan automatically converts into a permanent mortgage, meaning there’s no new approval process or loan origination fees.
This type of financing is ideal for homeowners looking for a streamlined, predictable process that keeps them on track with construction plans.
How does a construction-to-permanent loan work?
While the construction-to-permanent loan process is straightforward, it involves several key stages:
Application and approval
Before construction begins, you’ll need to go through the loan process, which includes submitting documents such as building plans, a draw schedule for payments, and proof of your credit history and debt-to-income ratio.
Construction
The construction phase is where all the pieces come together. As your home takes shape, expenses can add up quickly. Staying actively involved is essential to keeping the project within budget. Remember two important things:
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- Interest payments: Throughout the construction phase, you’ll pay interest payments only, typically on the funds that have been drawn so far. This keeps your initial payments low, but always monitor the cost of construction as it progresses.
- Draw funds: The lender doesn’t release all the money right away. Instead, you receive funds in stages as your project reaches key milestones listed in your draw schedule. For example, once the foundation is laid or framing is completed, the lender will release more funds to continue building.
Expect the construction phase to include several inspections and paperwork at different stages.
These steps are crucial for maintaining the project’s timeline and avoiding costly delays or
overruns.
Permanent financing
The construction loan becomes your mortgage when your home is complete. You’ll then start making monthly payments covering both the loan amount and interest.
Why choose construction-to-permanent financing?
For many, the simplicity of construction-to-permanent financing is a huge draw. With one loan
and one closing, you avoid the hassle of securing a separate loan for permanent financing once
construction ends. Here’s why it makes sense:
Fewer closing costs
With a single-close loan, you avoid paying closing costs twice, saving you money while
speeding up the entire process.
Rate mortgage options
When your construction loan transitions into a permanent loan, it could have a fixed interest rate
or an adjustable rate. The former provides consistent, predictable payments, while the latter
typically starts with lower rates that may change over time based on market conditions.
Payment structure flexibility
During construction, your interest-only payments keep things manageable, so you don’t have to
worry about costly payments while your home is still under construction.
What do lenders typically look for in construction-to-permanent loans?
When applying for construction financing, lenders typically want to see the following:
Strong credit score
Lenders use your credit score to decide if they’ll approve you for a loan and to set the interest
rate they’ll offer. Scores between 670 and 739 are considered a good indicator that you’re a
reliable borrower who repays loans on time.
Realistic construction plans
Lenders want to see construction plans that are thorough, with accurate timelines and cost
estimates. Your builder will need to provide these documents, and the plans should align with
the agreed-upon budget.
Down payment and loan amount
Most lenders ask you to pay some money up front, usually about 10–20% of the total amount
you want to borrow. Since your loan amount will vary based on your construction plans and
associated costs, it’s crucial to have sufficient capital set aside to cover these initial upfront
expenses.
What differentiates a construction-to-permanent loan from traditional mortgages?
While traditional mortgages and construction-to-permanent loans are both types of home loans,
there are notable differences:
- Traditional mortgage: Used to purchase an existing home, traditional mortgages
involve a single loan, with interest payments and principal payments starting from day
one. - Construction-to-permanent loan: This covers both construction and permanent
financing for homes, with interest-only payments during the build phase and automatic
conversion to a permanent mortgage once construction finishes.For those who are building a custom home, the construction-to-permanent route is often more
convenient and cost-effective than securing separate loans.Do I have other financing options for new construction?
Aside from construction-to-permanent loans, there are other options for new construction
financing, including: - Construction-only loans: These are short-term financing options designed specifically
for the construction phase of a home. Once construction is finished, you’ll need another
loan to pay the builder. - Cash-out refinance: If you already own property and plan to renovate or build on it, a
cash-out refinance can be an option to free up equity for the project. - Government-backed loans: For eligible individuals, Federal Housing Administration
loans or Department of Veterans Affairs loans may offer more affordable down
payments, which can be advantageous for first-time builders.
So, should you get a construction-to-permanent loan?
With one loan, one closing, and interest-only payments during construction, a
construction-to-permanent loan provides a convenient, predictable path from building to
permanent ownership.
But before you apply, consider your credit score, the loan amount you need, and your overall
financial readiness for a construction project. Partnering with a trustworthy builder and knowing
the ins and outs of the loan process are also key to keeping your project on time and on budget.
If you’re ready to take the next step, Directions Home Loan is here to guide you through the
process with competitive rates, expert advice, and reliable customer service. Contact us today
to discover how a construction-to-permanent loan can bring your dream home to life.
