Construction to Permanent Loans: A Complete Guide

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Construction to permanent loans, also known as end loans, are a type of financing option for home buyers looking to build a new home. With a construction to permanent loan, the borrower takes out one mortgage to cover both the construction period and the permanent financing once the home is completed. This eliminates the need to obtain separate construction and permanent mortgages.

How Construction to Permanent Loans Work

A construction to permanent loan is structured in two phases:

Phase 1: The Construction Phase

During the construction phase, the lender disburses the loan amount in increments as the home is being built. This provides the financing to pay the builder during the construction period, which typically takes 6-12 months.

The borrower only pays interest on the amount disbursed so far, not on the full loan amount. This helps keep payments low during construction. The interest rate is usually adjustable during this period.

Phase 2: The Permanent Financing

Once construction is completed and the home is ready to be occupied, the loan converts to the permanent mortgage. This is the mortgage the borrower will pay off over the full loan term, typically 30 years.

At conversion, the interest rate locks in at a fixed rate. The borrower now makes principal and interest payments amortized over the remaining loan term. Any remaining loan balance gets rolled over to the permanent mortgage.

Benefits of Construction to Permanent Loans

There are several advantages that make construction to permanent loans appealing to home buyers building a new home:

One loan for the entire process – The single loan simplifies the financing process versus getting separate loans for construction and permanent. Closing costs and fees are reduced by only needing one loan.
Lower payments during construction – Paying interest-only on the disbursed amount keeps payments lower until the full mortgage shifts to principal and interest. This helps improve cash flow during the building phase.
Quick turnaround on draws – Builders can get fast access to funds as construction progresses, which helps the project move efficiently. Lenders disburse payment in increments as inspection benchmarks are met.
Fixed-rate permanent financing – The interest rate converts to a fixed rate once the home is completed, locking in low rates for the long term. This provides payment stability when the full mortgage kicks in.
Easier to qualify than a construction loan – Construction loans have stricter qualification standards. With a construction to permanent loan, borrowers generally only need to meet standard mortgage qualification criteria.

Eligibility and Requirements

While construction to permanent loans offer excellent benefits, borrowers must meet certain eligibility and underwriting requirements to qualify:

Credit score – Most lenders require a minimum credit score of 620 or higher. The stronger your score, the better your chances of approval and interest rate.
**Down payment **- Expect a down payment between 10-20% of the total loan amount. More is better to reduce payment shock when the permanent financing starts.
Debt-to-income ratio – Your total monthly debt obligations, including the future house payment, usually cannot exceed 45% of your gross monthly income.
Loan-to-value ratio – The loan amount generally cannot exceed 80% of the completed home’s appraised value. So your down payment plus the loan amount must equal 80% LTV or lower.
Reserves – Expect to show reserves equal to 6-12 months of mortgage payments. Reserves provide a cushion in case construction goes over budget.
Construction budget and timeline – You’ll need to provide detailed construction plans and specifications along with a realistic budget and schedule. Cost overruns can put you over the loan amount.

The Construction Draw Process

During the construction phase, the lender releases funds to the builder in pre-determined installments called draws. Here is how the draw process typically works:

The first draw is approved once construction begins, providing initial funds to start the project. This may be 10-15% of the total building costs.
The lender will order inspections after each stage of construction is complete before approving additional payments. Inspections ensure work is on schedule and conforms to specifications.
When an inspection milestone is reached, the builder submits a draw request to the lender for the next increment of funds. This continues after each stage until the home is finished.
The lender retains 10-15% of the total costs until the end, which is released once the home passes final inspection and obtains a certificate of occupancy from the local municipality.
It’s important to build in a contingency fund for unexpected overages. Going over the loan amount can put you in default.

Finding the Best Construction to Permanent Loan

If you’ve decided to build a new home using construction to permanent financing, here are some tips for finding the best loan program:

Shop multiple lenders – Compare loan options, rates, and terms from several lenders. Online lenders tend to offer the most competitive rates.
Look for flexible draws – Find a lender that offers draws as milestones are met, rather than at set intervals. This ensures you only pay for completed work.
Prioritize good communication – A lender that communicates regularly and provides timely draw payments and inspections helps the project run more smoothly.
Check reviews and complaints – Research reviews and complaints against any lender you are considering to ensure they have a solid reputation for construction loans.
Compare total costs – Look at interest rates but also factor in fees, closing costs, and any upfront premiums to determine the true total cost of the loan.

Alternatives to Construction to Permanent Loans

Construction to permanent loans have excellent benefits but aren’t necessarily the best option for every home buyer. Here are a few alternatives to consider:

Construction loan + standard mortgage – You can get a shorter-term construction loan for the building phase, then a separate permanent mortgage once the home is complete. This may provide more construction loan options but requires refinancing.
Portfolio loan – Some banks offer this type of construction loan that they keep on their own books. Approval is based more on your relationship with the bank than your creditworthiness.
FHA One-Time Close loan – This special FHA-insured mortgage combines construction and permanent financing but requires just one closing. It provides low down payments but limits the total loan amount.
VA construction loan – Veterans and military members have access to VA construction loans requiring little or no down payment. Like FHA loans, the funding comes from a single closing.
Owner-builder construction – If you have the skills, you can act as your own general contractor and subcontract out work. This gives you maximum control but also the most responsibility during construction.

Questions to Ask Mortgage Lenders

When shopping construction to permanent loans, here are some key questions to ask prospective lenders:

What are the interest rates and terms you offer for construction to permanent loans?
What fees and closing costs are associated with this type of loan?
What are your qualification standards for borrower credit scores, income, and assets?
How much in contingency reserves will I need to show?
How often are construction draws provided, and what triggers a draw release?
What kind of communication and inspection schedule do you provide during the building process?
What happens if the construction timeline or budget needs to be extended?
Do you require an interest rate lock for the permanent financing conversion?
How long does it usually take you to approve draws and provide funding?
Can I choose my own builder, or do you have approved partners?

Conclusion

Construction to permanent loans provide an all-in-one way to finance a custom built home. With just one loan covering both the construction period and permanent mortgage lender, the process is simplified compared to obtaining separate mortgages. Lower payments during construction and access to fast draw funding help projects progress smoothly and efficiently. While these loans have stricter eligibility standards, they can be an excellent, low-hassle way to finance a new dream home.

ALEX