Construction to permanent loan

You need to understand what a construction to permanent loan is. Here’s what to know.

What is a construction to permanent loan?

A construction to permanent loan is a loan used to finance the construction of a home. When the home is complete, it converts into a permanent mortgage loan. Another common term for a construction to permanent loan is a single-close loan.

Deeper definition

Mortgage loans are only granted on structures that already exist. They cannot be used when you want to buy land and build a home. For that, you need a construction loan, which is a short-term loan allowing you to buy land and build.

A unique feature of a construction loan is that it’s like a line of credit. You only draw what you need, and interest is only charged on the amount drawn. Because the lender organization has limited surety, it generally insists on inspecting you and your plans, using an accredited builder.

On completion, the building is inspected for compliance to the plan and to local ordinances. Once the home is completed, a separate mortgage has to be taken out, using the home as collateral.

The problem is that two separate loans have to be taken out, meaning two sets of costs. Also, the market may change during construction, and it may be more difficult to obtain a mortgage to finance the completed home.

The construction to permanent loan avoids this dilemma because it starts as a construction loan. When the building is complete and inspected, it automatically converts to a permanent mortgage loan.

Because of increased risk, the interest charged on construction to permanent loans may be higher. It’s always wise to compare the cost of the alternatives before proceeding. In both situations, lenders will normally expect you to put down a substantial deposit of at least 20 percent.

Construction to permanent loan example

Katherine and Paul are planning to build their dream home. They work with a respected architect to design the home and approach several contractors for initial cost estimates.

Using this information, they apply for a construction to permanent loan from their bank. Because they have taken care to ensure everything is fully documented and that the planned structure complies with local regulations, the loan is granted and they can proceed.

Are you planning to build or buy a home? Use Bankrate’s prequalification calculator to find what mortgage you qualify for.

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