Conventional mortgage loans cannot be used to buy a plot of land to build upon, or to complete a semi-built home. Many people attempt to take out a short-term loan for the purchase of the lot and the construction of the home, and then apply for a mortgage to pay off the short-term loan once the construction on the home is complete. Although this may work for some, many people run into the issue of not qualifying for the mortgage because their credit or income dropped after taking out a short-term loan.
Construction-to-permanent loans are the solution to this issue. It is a type of mortgage loan option that allows the borrower to both finance the construction and purchase a new home, without having to re-qualify for a separate mortgage.
- Potentially save money on closing costs
- Avoid underwriting complications
- You don’t have to re-qualify for the actual mortgage after the home has been built
- Your credit only reflects one loan, not two
- 15 year or 30 year terms
- Lock in interest rate when you apply
- Inflexible rate options
- Strict timelines for construction
- May pay more in interest than a standard mortgage
- Building delays put loan at risk of cancellation
How the Loan Works
The loan begins as a construction loan and, once approved, you can use some of the proceeds to purchase the lot; then, the builder is paid for each phase of construction. During the construction phase, you are provided the option of making “interest only” payments. During this phase, interest rates are variable, but it can be changed to a fixed rate once construction on the home is complete. Once the building is done, your construction loan is rolled into a standard mortgage, available as 15 or 30 year terms.
The Interest Rate on a Construction-to-Permanent Loan
During the construction phase, you will have a variable interest rate that can change on a daily basis. It is affected by the current changes in the real estate market and the economy as a whole, and published in the Wall Street Journal in the Money Rates section.
You only have one closing date with a construction-to-permanent loan, so your interest rate for the actual mortgage is locked in at that time — well before your home is even built. This can either be good or bad over the long run. If interest rates drop by the time your home is completed, you are stuck with a higher interest rate; however, you might be lucky and avoid a rise in mortgage rates.
Other aspects of a construction-to-permanent home loan include:
- Strict timelines for the building phase
- Lender must approve construction blueprints
- Your loan can be cancelled if building delays (or other issues) prevent the construction deadline from being met.
- A licensed real estate appraiser will need to inspect your home after construction is complete to verify blueprints match construction.
If the building timelines are met and the home passes inspection, then the mortgage phase of your loan will be approved by the lender to begin. The process can be tedious, but at the same time can be extremely beneficial to a borrower who wishes to build on their own land or buy land to build upon without having the hassle of multiple loans.
Construction-to-Permanent Home Loan FAQs
- What is the approval process like for construction-to-permanent loans? The approval process for construction-to-permanent loans is similar to that of a typical mortgage. Underwriting will still review your income, assets, liabilities, credit history, and the property appraisal before granting approval for the loan. The only real difference is that appraisal will be based upon the improved value of the property after construction is complete, which may allow you to borrow more.
- How long does the approval process take? Construction-to-permanent loans can take 7 to 10 business days longer than a traditional mortgage loan. This additional time is so that your lender can review the blueprints and builder’s contracts for approval.
- What do I need to apply? In addition to your application documents, you will also need to provide the following documents in order to apply for a construction-to-permanent loan:
- A copy of the deed to the land (needed whether you own it or are purchasing it)
- HUD-1 Settlement Statement for the purchase of the land, if you purchased it within 12 months of applying for the loan
- Contract for the purchase of the land, if you don’t own it already
- Contract with a builder
- Complete builder information: Company name, address, phone number and federal tax ID number
- Plans and specifications for the home
- Certificate of liability insurance for the builder
- Builder’s risk/homeowner’s policy
- Building permit – only required if builder wants disbursements at closing (no more than 10%)
- Are fees different for a construction-to-permanent loan? The closing process for a construction-to-permanent loan is similar to any other mortgage closing, but there are some additional fees you may see with only construction-to-permanent loans, including:
- Fees for inspections
- Fees paid to the title insurance company for title updates