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What Is a Construction to Permanent Loan?
Key takeaways
- A construction to permanent loan provides short-term funding for the construction phase of building a home and then converts into a longer-term mortgage
- Funds are disbursed in draws to approved builders. During construction, you typically make interest-only payments on the amounts used
- Eligibility often requires strong credit, detailed plans, and licensed builders; terms, rates, and down payment minimums vary by lender
A construction to permanent loan is a borrowing option that can simplify new-home construction financing. Commonly referred to as a one-time-close construction loan or single-close loan, it converts into a traditional mortgage once construction is complete.
Its ability to automatically transition from one loan type to another can streamline the lending and closing process because you don’t need multiple applications or separate closings.
How does a construction-to-permanent loan work?
If you're asking "What is a construction to permanent loan?" it helps to understand how the two phases of funding work with one another.
During the home's construction, the first round of funding is released in stages called draws. Different parts of the building process, such as the foundation, framing, and interior work, trigger these construction loan draws.
The draws are paid directly to the builder, and you, as the loan holder, typically make interest-only payments based on the total amount of funds withdrawn. This structure can help keep the monthly repayments more manageable while the home is under construction.
Once the construction phase ends, the loan changes into a permanent mortgage with:
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A fixed or adjustable interest rate. Your interest rate may stay the same throughout the life of the loan, or it may change over time, according to the terms
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Full principal and interest payments. Monthly payments shift to include principal repayment, along with interest
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A standard repayment term (commonly 15 or 30 years). Repayment typically spans a fixed length of time, regardless of rate type
What are the benefits of a construction to permanent loan?
From breaking ground to final inspections, building a home involves many moving parts that could cause delays and frustration if the right type of funding isn't in place. Construction to permanent loans are a popular option for several reasons.
1. One loan, one closing
When building a home with traditional financing, you may need at least two loans: one for construction and one for the mortgage. With a construction to permanent loan, there's no need for separate financing or multiple closings. This can reduce approval times, closing costs, and paperwork. It also could simplify coordination with the lender.
2. Interest-only payments during construction
Making interest-only payments during construction may help you better manage your cash flow as your house is built. It could give you more leeway to cover building-related fees, temporary housing, or unexpected costs that come up during construction.
3. Protection from rising interest rates
Depending on the terms of the loan, you may be able to secure a rate lock during construction or before the building even begins. This feature could be especially appealing if interest rates are on the rise. You could lock in a lower rate, eliminating worries about future rate increases.
4. Smoother approval process
Part of the stress of building a home can come from the underwriting process to acquire funding. For each loan, you typically submit documents, provide income verification, go through credit checks, and respond to follow-up requests. A construction to permanent loan could reduce this burden because you only need to go through this process once.
5. Easier budgeting and planning
Certain combined construction and mortgage loans can provide an early insight into what your future mortgage payments might be. This type of clarity could make it easier to plan your down payment and manage long-term budgeting with fewer surprises. The ability to withdraw funds using a custom construction loan draw schedule may also support smoother cash flow during the build.
Drawbacks of a construction to permanent loan
Construction to permanent loans can suit borrowers with strong credit and clear plans for construction, but they could have drawbacks for some borrowers. Understanding these downsides might help you decide whether this type of loan is right for you.
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Stricter qualification requirements. Construction to permanent loans might require higher credit scores, more extensive income verification, and stronger financial documentation than a standard mortgage
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Larger down payment requirements compared with some standard mortgages. Qualification may require a bigger upfront cash contribution for the down payment (20% or more), which could be challenging for some borrowers
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Higher interest rates during the construction phase. Some loans come with higher construction-phase interest rates. This could occur because the lender has an increased risk during construction
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Extensive documentation for builder approval. You may need to use approved builders or go through a lengthy review process to verify the qualifications and credentials of the builders you want to use
Construction to permanent loan vs. separate construction loan
Construction to mortgage loans are different from separate (stand-alone) construction loans in several ways. Let's review the trade-offs between these two homebuilding loan options.
Construction to permanent loan
A construction to permanent loan keeps both phases of the build under one financing arrangement.
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One application. You apply once for a loan to cover the entire process
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One closing. There is only one closing, at the beginning of the project
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Converts automatically to a long-term mortgage. The loan automatically transitions when construction is completed
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Interest-only payments during construction. This could lower payments during construction, which can be helpful if you still are paying a mortgage or rent on a current dwelling
Separate construction loan and mortgage
This option separates the construction phase and the mortgage into two distinct loans.
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Requires two applications. You'll need to apply separately for each loan. Your financial situation and/or economic conditions could change while the home is being built, and it might be more difficult to get that second application, for a mortgage, approved
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Two closings. Closings can be time consuming and stressful, and you may face additional costs if you want legal representation at two closings rather than one
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May involve two sets of fees. Closing costs, which include the fees involved in your loans, generally are estimated to be 2%-5% of the loan value. Having two closings can increase your overall costs
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Interest-only payments during construction, followed by a refinance. Home builders typically refinance their construction loan into a mortgage. This requires shopping for and managing two different loans
A construction to permanent loan typically is simpler and could be more cost-effective, if you meet the qualification requirements and have a clear construction plan in place.
Who should consider a construction to permanent loan?
Borrower profiles that could match well with single-close construction loans include:
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You plan to build a home from the ground up
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You want to streamline the financing process
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You want reduced closing costs on construction loans
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You prefer to lock in your mortgage rate early
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You want predictable long-term payments after construction
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You have strong credit and approved, reliable builders
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You have solid building plans, including a construction timeline and budget
These loans may appeal to borrowers who appreciate having their financing details settled early.
FAQs
There are two parts to a construction to permanent mortgage loan. During construction, funds are released in draws directly to the builder, and you typically make interest-only payments on amounts used. After completion, the loan converts to a standard mortgage with a fixed or adjustable rate and full, principal-and-interest payments.
No, you do not needtwo closings with a construction to permanent loan. A single closing covers the construction phase and the mortgage. The need for fewer approvals may streamline the process and help you to spend less on closings, depending on lender terms and your specific loan.
As the home is being built, you typically make interest-only payments on the amount of money withdrawn so far. As additional draws are taken, these interest-only payments may increase. They do not go toward reducing the principal.
The lower monthly payments at the start of the loan could provide relief for cash flow. You won’t begin making full, principal-and-interest mortgage payments until construction is complete.
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