A construction to permanent loan is a loan that brings you through the entire process of buying and completing construction with a single loan.
This loan helps you avoid having to obtain separate lots and construction financing, lowering the number of moving pieces. Toward the end of the construction period, you’ll be able to work with your lender to change the construction loan into a permanent loan. This type of loan can lower the confusion, paperwork and headache associated with getting several different loans and financing options. It makes sure everything is in one place. However, you must apply for it just like any other loan, and just like any other loan, this one depends on whether you own the land.
If you do not own the land you’re building on, a construction loan is very beneficial in simplifying the borrowing process to one closing transaction.
If you own the land you’re building, remodeling or fixing up, a construction loan is still extremely beneficial. It will make sure you have the funds you need to build on or fix up, the property you currently own, helping you transition into a permanent loan.
What Is a Construction to Permanent Loan?
Construction to permanent financing is a type of loan which allows you to build or renovate your home. When the construction is done, this loan rolls over into a traditional mortgage without you having to go through another closing. This means you’ll only have to pay for one set of closing costs.
A construction to permanent financing loan may be right for you for a number of reasons. This financing allows you to borrow up to $2 million. Construction to permanent mortgage rates are also locked in when you apply, so you may not have to worry about increasing interest rates as you build.
You can use this type of loan for a lot, a build on your lot or renovations. It can cover labor and material costs for your primary or vacation residence. Your property must also be a one-unit, single-family home to qualify for a construction to permanent loan.
During the construction phase, you’ll make interest-only payments, and your lender will schedule home inspections to check in on how the construction of the home is progressing. After closing, you use the remaining savings from your down payment to pay your builder so they can begin construction. When your remaining down payment savings are gone, you can then draw from your construction to permanent loan to fund the costs of construction.
After the construction is complete, the loan will then become a permanent loan, such as a conventional loan with a 30-year term.
About Construction Loans and Uses for Construction Loans
No matter how excited you are to begin the construction process on your dream home, you may still be feeling a bit overwhelmed about all the unknowns of construction loans. That’s why we want to help you understand the basics — so you can feel comfortable moving forward with the construction process.
1. Types of Construction Loans
You can obtain one of two main types of construction loans:
- Stand-alone construction loan: In this situation, you’ll acquire two separate loans. The first is solely for the construction of your home — the stand-alone construction loan. This loan covers your construction costs. After construction is complete, you’ll secure a separate traditional loan.
- Construction to permanent loan: In this situation, you’ll obtain only one loan. At first, the loan pays for the home’s construction costs. Then, after you move in, the loan converts into a permanent loan. Essentially, you get two loans in one rather than dealing with two separate loans.
With a stand-alone construction loan, you pay for two sets of fees and for two closings, while you only pay for one set with a construction to permanent loan. With a construction-only loan, you may also have to pay a higher interest rate on the permanent loan, whereas your interest rate is locked in with a construction to permanent loan. This means you know exactly what your terms and costs are with a construction to permanent loan, and you won’t have to deal with an interest rate that’s higher than you expected.
If your financial circumstances worsen during the construction of your home, it may become much more difficult for you to qualify for a permanent loan.
2. Drawing From Your Loan to Pay for Construction
Unlike conventional loans, construction loans aren’t paid out in a single lump sum. Instead, they’re paid out in smaller installments known as draws. The lender pays out these installments throughout the construction process, and when the construction is completed, the lender transfers the total amount of the cost to you, the borrower.
A draw goes to the builder for reimbursement of the construction costs. Because a draw is a reimbursement, either you or the builder need to pay for construction costs upfront. Before these draws can be made, the lender will perform an inspection to estimate the cost and assess how progress is being made.
3. Construction Loan vs. Home Equity Line of Credit
When it comes to home improvements, you may want to select between a construction loan and a home equity line of credit (HELOC). A HELOC is a line of credit that a lender gives to the borrower against the equity in their home.
- A HELOC has a fixed interest rate and is repaid over the home loan term, which is typically 15 to 30 years.
- A construction loan will have higher monthly payments because of its limited term, usually three to five years.
- You’ll typically pay less interest for a construction loan than for a HELOC because construction loans have a fixed interest rate over a short duration, while a HELOC is generally repaid over many years.
- A HELOC will typically be repaid in interest-only payments for the initial five to 10 years. The interest rate will increase when you begin making principal payments.
Construction loans aren’t just used for building a new home — they can also be a great loan option for home improvements.
We’ve created these guides to be a valuable resource to walk you step-by-step through your next adventure.
The Construction Phase and How It Works
During the construction phase, you’ll navigate disbursements, inspections, draws and statements.
- Disbursements: Before you receive each of your loan fund disbursements, your lender schedules an inspection to check in on the initial work. You use your own funds first and then receive loan disbursements. The amount you receive in a disbursement corresponds to the construction progress. Your lender disburses funds to reimburse for materials installed or labor completed.
- Inspections: You can contact your lender so they can schedule an inspection to determine the percentage of work that has been completed according to your draw schedule. You also may want to schedule an inspection if you’re concerned about the quality of the workmanship on your home.
- Draws: Once you place a draw request, your lender will generally release those funds within two to three business days.
- Statements: In the month after your initial disbursement, you’ll receive monthly statements. Each statement will list the interest that has accrued on the disbursed loan funds.
The Process of Moving a Construction Loan to a Permanent Loan
There are several steps to move a construction loan to a permanent loan:
- Finish construction: A construction loan typically has a loan term of six months to two years. The process of building the home is considered finished when the loan disbursements and draw periods are completed and every party has been paid for labor and materials.
- Schedule a final inspection: After construction is completed, you need to schedule a final inspection. The building inspector will make sure your property complies with the building codes in your area. When the inspection process is successfully completed, you’ll receive a Certificate of Occupancy.
- Shop for a permanent loan: After the home is built, inspected and certified, you can start browsing your options for a permanent loan. A loan conversion will already be in place for a construction to permanent loan, but if you have a construction-only loan, this is the point in the process when you’ll begin searching for the right mortgage for you.
- Schedule an appraisal: During the appraisal, the property will be assessed to determine its value in comparison to other property sales that have occurred in the area recently. This can be tricky if there aren’t many comparable sales. If you have the nicest home in the area or a home that is unique for your neighborhood, then it may be difficult for your appraiser to find comparable properties, and this can have a major impact on how your home is valued. The appraisal is key for securing a conventional, permanent mortgage so that the lender can assign a value to the collateral.
- Apply for a permanent mortgage: Now you’re ready to apply for a permanent mortgage. Keep in mind the requirements for the types of mortgages you’re interested in, such as your credit score, your cash reserves and your debt-to-income ratio. These factors will determine whether you qualify for certain mortgage options. For an idea of how payments are calculated, you can use our home mortgage calculator.
- Finish the conversion: After the loan has closed, you’ll begin making your mortgage payments.
The Benefits of Construction to Permanent Loans
Let’s go over the basics — a construction to permanent loan will let you borrow upwards of $2 million, locking in interest rates when you apply and enabling you to finance a lot or build on a lot for your primary residence or vacation home. Now let’s cover the specific benefits of a construction to permanent loan for your home construction.
1. Save Money and Time
The main benefit of construction to permanent loans is that you do not have to choose a construction loan and then close on a second, permanent loan when your construction is complete. This will save you the hassle of finding an additional loan and save you money on closing since you’ll only have fees associated with closing on one loan.
At the end of the construction period, your home construction financing will be converted into a permanent loan without additional closing costs. At which point, you will begin paying both interest and principal each month. By securing a construction loan and permanent mortgage at once, you’re also avoiding any changes in the market during or after construction. This means you can avoid potentially higher interest rates, saving you money in the long-term.
2. Easier to Qualify
Construction to permanent loans are also easier to qualify for than stand-alone construction loans. A construction loan is riskier for a lender because there is no existing home they can use as collateral if you can’t pay back the loan, so the borrower has to meet a lot of eligibility requirements. You’ll need to supply your lender with details about the contractors and subcontractors, the materials that will be used and the home’s size. The lender also needs to believe that you can pay your monthly payments for you to qualify. This may mean having an excellent credit score, cash reserves, a significant down payment and a low debt-to-income ratio.
For borrowers who don’t have these qualifications, a construction to permanent loan is generally a better option than a stand-alone construction loan. In some cases, you may not be able to qualify for a construction-only loan, so a construction to permanent loan may be your only option.
3. Interest-Only Payments During Construction
Along with this, you get a 12-month construction period where you make interest-only payments on already distributed funds. As you transition into a permanent loan, you can decide if you want a fixed or adjustable rate loan for financing.
By not having to pay down the principal during the construction phase, your payments will be lower, and you’ll have more time to save or spend that extra money on unexpected construction costs.
4. Flexible Terms
Even though you’ll provide your lender with plans for the property’s construction, a construction loan tends to be more flexible than a traditional loan in its guidelines and loan terms. You can probably adjust your loan terms to work with your needs as progress is made on your new property.
If you want to build your own home on a lot you have or extensively renovate your property to make it your dream house, a construction to permanent loan may be the right financing for you.
Disadvantages of Construction to Permanent Loans
Though a construction to permanent loan is an excellent option for many borrowers looking to build a new home, there are a few disadvantages to this type of loan or instances in which you may want to opt for a different loan.
- Potentially higher interest rates: Interest rates on construction to permanent loans tend to be higher than conventional loans because of their increased risk. A lender needs to be sure that they are making a smart investment by allowing you to borrow money, and they will make sure they are protected by charging a higher interest rate than you may be able to find for other mortgage types.
- Larger down payments: For a construction to permanent loan or a construction-only loan, lenders typically want a substantial down payment. Depending on the anticipated cost of your home, you may have some difficulty saving up a down payment of 20% or more.
If the construction loan is for a second home, you may want to take out a stand-alone construction loan if you can pay a smaller down payment, and you’ll sell your first home to move into the new construction. Ideally, you’ll have a lot more cash after you sell your current home, and you can continue living in your home while the second property is being built.
What Are the Requirements for a Construction Loan?
Construction to permanent loan lenders may be taking a larger risk with a construction loan than with a traditional mortgage. After all, much can happen during the construction process. Renovations and builds can be delayed or go over budget, and the final result may not be worth as much as projected.
To protect against these issues, construction to permanent loan requirements require you to have:
- A good builder: You will need to speak to an experienced builder who has worked on similar projects and is licensed and insured. Check recommendations and backgrounds carefully to find a licensed general contractor who can do the work.
- Details of the build: Once you have a builder, make sure you have what is known as a “blue book” of the construction project, which will list everything from floor plans to the materials you will be using in your new home or renovation.
- Good credit: You may need a credit score of 680 and ideally of 700 to 720 or higher to qualify for this type of financing.
- An estimate: You may need to work with an appraiser to determine the expected home value. Whether you need this step will depend on your circumstances and your lender.
- A down payment: You may need a down payment of 20%, but this number may vary widely, depending on your assets, circumstances, proposed project and more. If you are not sure how much you need, you can speak to a loan officer at Assurance Financial to get details about how to qualify for a loan.
- Cash reserves: A construction loan is paid out to reimburse the builder, which means the builder or the borrower needs to have the cash reserves to cover the costs of construction upfront. This can mean a borrower needs to save up a lot of money beforehand.
You’ll also want to understand the equity of your home in relation to getting a construction loan or a home equity line of credit. You’ll need equity in your home to take out a HELOC. Your line of credit will be based on the equity you have in your home — not based on your home’s total value.
Understanding the requirements for obtaining a construction to permanent loan is key to ensuring you will qualify for a loan when you’re ready to build your dream home.
Construction to Permanent Loan Rates
Because a construction to permanent loan is locked in for a long-term basis, you may get a higher interest rate. The longer the term of the loan, the higher the interest rate tends to be. Your rate may also be higher if the owner of the property is also the builder, as the construction may not be of the same quality and meet the standards as the construction of a licensed contractor. Fortunately, as your home gets closer to completion, you may be able to get a lower rate.
With a construction-only loan, you may be able to get a lower rate since the loan will be for a shorter duration. However, with a construction-only loan, you also risk getting a higher interest rate for your permanent loan if the market changes or if your financial situation worsens.
Construction to Permanent Options and Loan Lenders
The right loan lender can provide you with a loan that has the terms you want. Not every lender offers construction loans, and some lenders will only offer construction loans if borrowers can meet rigorous requirements. That’s why comparing lenders is so important when it comes to finding the best lender and loan for your home construction.
Assurance Financial has several options for your construction to permanent loan needs. We have these single-closing loans and two-closing loans if you prefer the added flexibility. We have loans for homebuyers and for builders. If you meet the requirements for a USDA loan and your project meets specific thermal standards, you may even qualify for USDA construction to permanent loans, which may come with competitive rates.
Assurance Financial understands it can be challenging to find the right financing product for you. If you have a vision for your home, come to us, and we may be able to help make that dream a reality with practical suggestions and loan products. Since we underwrite in-house and don’t shop your mortgage around, we may be able to offer flexibility to help meet your needs.
Apply for a Construction to Permanent Loan Today
You don’t want a loan — you want a home. Assurance Financial understands that. It’s why we pride ourselves on being The People People with technology. We treat you like a person, not a number, and we explain your options in plain English. We are not just about numbers, but rather about your homeownership goals.
Our goal is to help more Americans reach the dream of homeownership. It’s why we focus on mortgages and offer a range of loan products to help you get into your dream home or vacation home. Whether you’re building your dream home or renovating or buying an existing home, Assurance Financial has loans for you.
You can apply for a construction-to-permanent loan in 15 minutes with Abby, your virtual assistant. The application is simple, with no need to know complicated terms or enter strings of numbers. Abby lets you sign in to your payroll and banks to instantly verify assets and income, which can help you speed up the application and means you don’t have to fax in statements.
If you prefer to speak to a person, we have mortgage experts licensed in 28 states. Our friendly and experienced professionals can listen to your goals and concerns and address them with customized advice.
In fact, even if you apply with Abby, your application is handled by a real person, so you don’t have to worry about being treated like a number or getting lost in a computer system.
Our process is simple. We pre-qualify you in 15 minutes by pulling your credit and offering you a free, no-obligation quote on a rate. Once you have found your home, builder, or are ready to refinance your property, simply fill out the full application. We take care of processing, including in-house underwriting, and let you know if you have approval. Once you sign with a notary to close your loan, you can get started on breaking ground on your new home or moving. Since we handle end-to-end processing without outsourcing, we can take care of your application quickly and answer your questions.
To start building your dream home, you need first to make sure you have all the funds required. We take the stress out of the entire process with our construction-to-permanent loans, making everything easier, faster, and all in one place.
If you need help converting your construction loan into a permanent one or are interested in financing a new build, contact our loan officers and let us help you find the perfect option for you!