Key takeaways

  • A construction-to-permanent loan finances the construction of a house, then converts to a mortgage on completion.
  • Construction-to-permanent loans only require one round of closing costs compared to construction-only loans, but require a down payment.
  • With a construction-to-permanent loan, you can draw funds at specific phases of construction, up to a certain loan amount.

A construction-to-permanent loan is one form of construction financing borrowers use to build a home. It can help with obtaining the land, materials, permits and more. Many types of lenders offer construction-to-permanent loans, but you’ll most often find them at a bank or with a lender that specializes in construction financing.

What is a construction-to-permanent loan?

A construction-to-permanent loan — also known as a one-time, single-close or construction-perm loan — is a type of mortgage for those building a home. It funds the purchase of land and the home’s construction. Once the home is built, the loan converts into a traditional mortgage, usually with a 15- or 30-year term.

Conventional construction-to-permanent loans can have fewer restrictions than government-backed loans.

How does a construction-to-permanent loan work?

Construction-to-permanent loans function in two phases: construction and post-construction. During the construction phase, the lender authorizes payments, or draws, to cover the cost of land, materials, labor, permits and other expenses. The lender works closely with an inspector to ensure the construction continues on-schedule and on-budget.

The construction phase typically lasts about one year but can vary depending on your lender, permitting, scheduling and the project’s size. During this time, you might only need to make interest payments. Once construction is completed, the loan converts into a traditional mortgage, and you’ll start repaying the mortgage principal and interest.

Construction-to-permanent loan eligibility requirements

Since there’s more risk involved with building a home, lenders typically have more stringent requirements for construction-to-permanent loans. Along with having your finances in order, you’ll need to submit detailed plans and work with approved professionals. Here are the typical requirements:

  • Down payment: 20 percent
  • Credit score: 680
  • Debt-to-income ratio (DTI): 45 percent or below to boost your application. 
  • An estimated appraisal: An appraiser will need to determine the home’s estimated completed value.
  • Project approval: The lender needs to approve your budgets, schedule, blueprints and more.
  • Architect and contractor approval: You’ll need to hire licensed, professional builders and submit copies of their licenses, certificates and/or resumes to your lender.

Pros and cons of construction-to-permanent loans

Construction-to-permanent loans have benefits as well as drawbacks. Here are the major ones to consider.

Pros of construction-to-permanent loans

  • Only one set of closing costs: Instead of taking out a construction loan, and then a mortgage, a construction-to-permanent loan combines the two, which limits your closing costs.
  • Ability to draw funds as needed: Construction-to-permanent loans pay out to builders as the project progresses.
  • Interest-only payments during construction: Many construction-to-permanent loans only require you to make interest payments during construction. This can make budgeting easier, especially if you have rent or another mortgage to pay while your new home is being built.

Cons of construction-to-permanent loans

  • Bigger down payment than other mortgages: Conventional construction-to-permanent loans are riskier for lenders because the home that normally serves as collateral isn’t built. Because of this, you could be required to make a higher down payment.
  • Cost overruns: If the project goes over budget (and most do), the loan amount might not cover it. In this case, you’d have to pay out of pocket or get another loan to cover the additional costs.
  • Higher interest rates: Construction-to-permanent loans, in general, are more costly than conventional mortgages. What’s more, the interest rate on the construction portion of the loan might exceed the permanent mortgage rate later on.
  • More paperwork: Because a construction-to-permanent loan combines a construction loan with a mortgage, you’ll need more documentation than a traditional mortgage. That means submitting blueprints, a budget and licenses for contractors.

How to apply for a construction-to-permanent loan

Applying for a construction-to-permanent loan has more steps than applying for your standard mortgage. Here’s what you’ll need to do to get started:

  1. Find a builder and an architect: Research potential builders and architects, read up on their reputations and ask for references. Then, set a budget and a timeline, and finalize the home’s design.
  2. Get a lender: Consider at least three offers from different lenders, comparing their rates as well as their experience funding construction-to-permanent loans. Once you decide on one, you’ll need to apply for the loan, submitting paperwork on income, assets, debts and more.
  3. Buy insurance: Your lender may require you to buy builder’s risk insurance or new construction insurance to cover the home while it’s being built.

Construction-to-permanent loan FAQ

  • Alternatives to construction-to-permanent loans include:

    • FHA construction loans: For as little as 3.5 percent down, you can get a construction loan insured by the Federal Housing Administration (FHA). These come in the form of a construction-to-permanent loan and the 203(k) loan, which is a renovation loan you can use to rehab an existing home.
    • VA construction loans: For eligible veterans, members of the armed services and their surviving spouses, construction loans guaranteed by the Department of Veterans Affairs (VA) offer an option to build a home with no down payment required.
    • Home equity line of credit (HELOC): If you have a house, you can tap into your home equity with a HELOC. With enough equity, you could use a HELOC to fund another home’s construction. However, keep in mind you’ll need to use your home as collateral and pay out of pocket for any construction costs not covered by the HELOC.
    • Cash-out refinance: Similar to a HELOC, a cash-out refinance will let you tap your home equity to construct another home. Unlike a HELOC, it replaces your current mortgage with a new mortgage for a new amount and new rate.
  • A construction loan only finances the construction of the home. Once the home is built, you’ll need to either repay the loan in full or take out a separate mortgage. A construction-to-permanent loan bundles the construction loan and the mortgage.
  • The lender pays the builder out in disbursements that are called “draws.” The lender and builder agree upon a draw schedule for these payments, and before making the payments, the lender works with an inspector to see that the agreed-upon work has been done.
  • Construction-to-permanent loans are only for building new properties. There are different loan options for renovating, including:

    • A personal loan: A personal loan can include a cap of $35,000 (though some lenders may offer more) for home renovations. When compared to mortgages or home equity loans, personal loans are financed faster. However, they often come with higher interest rates.
    • A home equity loan or line of credit (HELOC): If you own a home with significant equity, you can tap into that equity with a home equity loan or a HELOC.
    • An FHA 203(k) mortgage: If you’re buying an existing home that needs a significant amount of work, a 203(k) mortgage can help you finance the home purchase, as well as the renovations.
  • If your construction is delayed, work closely with your lender and builder to resolve the delay. Frequent communication could go a long way to avoid issues with the loan. Still, significant delays could affect you due to changes in your interest rate, resulting in a higher payment. Your mortgage lender may also not disburse funds to the builder, which could complicate the construction.