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A construction to permanent loan is one form of construction financing borrowers use to build a home, including obtaining the land or lot, permits and more. Many types of lenders offer construction to permanent loans, including conventional, FHA and VA options.
How do construction to permanent loans work?
A construction to permanent loan is one of several kinds of construction loans. With the permanent option, borrowers get a mortgage to finance the building of a home, then convert that mortgage to a permanent loan once construction is finished. The permanent mortgage is typically a 15-year or 30-year loan, with a fixed or adjustable rate.
During construction, the construction loan lender authorizes payments, or draws, to the builder. These payments go toward labor, materials, permits and other costs. The lender checks in at various stages in the process to inspect the work.
Throughout the construction, the borrower usually only makes monthly interest payments on the loan. When the loan converts, the borrower makes monthly principal and interest payments, similar to a regular mortgage.
A construction to permanent loan might also be referred to as a one-time or single-close construction loan.
Construction to permanent loan pros and cons
- Ability to draw funds as needed: Because of how construction to permanent financing is structured, the borrower won’t take out — and need to repay — more than necessary for the project.
- Cheaper than construction-only loans: With a construction to permanent loan, the borrower only pays for a single transaction. This is in contrast to a construction-only loan, which involves closing on one loan for the project and then another loan, known as an end loan, once the borrower moves in. This means more money spent on closing costs and other fees.
- Interest-only payments to start: During the construction phase, the borrower typically only pays interest, usually at a fixed rate. This lower (and more stable) monthly payment might make budgeting easier for a time.
- Bigger down payment: Construction loans are riskier for lenders to offer, in part because the asset a mortgage is normally secured by — the home — hasn’t been built yet. To compensate, borrowers typically need to put down at least 20 percent. (One possible upside, however: Borrowers might be able to apply money spent on permits or other project expenses toward the down payment.)
- Cost overruns: If the project goes over budget (and most do), the loan amount might not be enough to see it through. In this case, the borrower might need to obtain another loan, or pay out of pocket.
- Higher interest rates: Construction loans in general are marked up somewhat compared to regular mortgages. What’s more, the rate on the construction portion of a construction to permanent loan might be higher than the permanent mortgage rate later on. This means higher monthly payments overall.
- More paperwork: Unlike applying for a traditional mortgage, the borrower usually needs to submit more documents, including the contract with the builder and the construction plans.
Construction to permanent loan lenders
Many banks and other kinds of lenders offer construction to permanent loans, including:
- Citizens Bank
- Go Mortgage (Not available in every state)
- Flagstar Bank (Not available in every state)
- FMC Lending
- M&T Bank (Not available in every state)
- Nationwide Home Loans (Not available in every state)
- TD Bank (Not available in every state)
- U.S. Bank
Construction to permanent loan vs. HELOC
A construction to permanent loan is not the same as a home equity line of credit (HELOC), but they work in similar ways.
With a HELOC, the borrower can draw funds from a revolving line of credit based on an existing home’s equity, as needed and for any purpose. Typically, the borrower pays interest during the draw period, then repays what was borrowed over a repayment term.
While a construction to permanent loan features the same ability to draw funds and make interest-only payments, the lender has to approve the draws before disbursing the funds, and the money goes to the builder, not the borrower.
A borrower might opt to use funds from the HELOC to finance home renovations, but likely won’t have enough equity to use it to pay for the ground-up construction of a new home.
A construction to permanent loan offers the convenience and lower cost of a single closing, but like other types of construction loans, has a bigger down payment requirement and some limitations.