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Construction-to-Permanent Loan

December 5, 2023
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Key Takeaways

Introduction:

A construction-to-permanent loan is a type of mortgage that provides financing for both the construction of a house and the subsequent conversion into a traditional mortgage. It is a convenient option for individuals who are building a home as it combines the two phases into one loan. 

Construction-to-permanent loans are typically offered by banks or specialized lenders and can help borrowers with obtaining land, materials, permits, and other necessary expenses.

Key Takeaways:

  • A construction-to-permanent loan finances the construction of a house and then converts into a traditional mortgage once the construction is complete.
  • It requires a down payment, although some lenders may allow for lower down payments compared to other types of loans.
  • Borrowers can draw funds at specific phases of construction, up to a certain loan amount.

How it Works:

A construction-to-permanent loan operates in two phases: the construction phase and the post-construction phase. 

  1. Construction Phase: the lender disburses funds, known as draws, to cover expenses such as land, materials, labor, permits, and other construction-related costs. An inspector works closely with the lender to ensure that the construction progresses according to schedule and budget. In most cases, borrowers only need to make interest payments during this phase.
  2. Post-Construction Phase: Once the construction is completed, the loan seamlessly converts into a traditional mortgage. Borrowers start repaying the principal amount and interest at this stage, following the terms and duration of a standard mortgage, typically with a 15- or 30-year term.

Key Components:

  • Eligibility Requirements: Lenders typically have stricter criteria for construction-to-permanent loans due to the increased risk. This may include a down payment of around 20%, a good credit score (minimum of 680), a low debt-to-income ratio (DTI), and an estimated appraisal of the completed home.
  • Project Approval: Borrowers must submit detailed plans, budgets, schedules, and any related documentation for review by the lender. They also need to work with licensed professionals, such as architects and contractors, who are approved by the lender.

Benefits:

  • One Set of Closing Costs: With a construction-to-permanent loan, borrowers only incur one set of closing costs, as opposed to separate costs for a construction loan and a mortgage. This helps to minimize expenses.
  • Ability to Draw Funds as Needed: Construction-to-permanent loans allow borrowers to access funds at specified stages of construction. This flexibility ensures that they have the necessary funds available as the project progresses.
  • Interest-Only Payments during Construction: During the construction phase, borrowers may only be required to make interest payments. This can assist with budgeting, especially if they have other financial obligations, such as rent or another mortgage.

Takeaway:

Construction-to-permanent loans offer a practical solution for individuals who are building a home. 

By consolidating the construction and mortgage phases into one loan, borrowers can streamline the process and eliminate the need for multiple sets of closing costs. 

However, it’s important to consider the higher down payment requirement, the possibility of cost overruns, and the potential for slightly higher interest rates. 

By understanding the eligibility requirements and carefully planning the project, borrowers can take advantage of the benefits offered by construction-to-permanent loans.

It’s recommended to work with experienced professionals in construction financing and mortgage lending to ensure a smooth and successful loan application and construction process.

Disclaimer: The information on this website, including glossary definitions, is for educational and informational purposes only and not intended as professional advice. While we strive for accuracy, we make no guarantees regarding the completeness, reliability, or timeliness of the information provided. We are not liable for any loss or damage arising from your use of the site. Investment decisions in commercial real estate should be made based on individual due diligence and professional advice. Laws and regulations are subject to change; always consult legal and financial experts before making decisions.

Sources:

https://www.bankrate.com/mortgages/construction-to-permanent-loans/

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