Building your own home requires specific types of financing. You are not eligible for the standard conventional loan because the home will not pass an inspection or appraisal because it is not complete. Because of this, you need to get a construction loan that will eventually turn into a permanent loan. You can choose to do this one of two ways: obtain a construction-to-permanent loan or refinance your construction loan into a permanent loan. There are advantages and disadvantages to both sides of the equation, but the fact of the matter is, if your credit, employment, income, or debt ratio were to deviate from what they were when you qualified for the construction loan, you could find yourself without a loan to pay off that construction loan, leaving you without a home to live if you choose the refinance option. Instead, the construction-to-permanent loan wraps everything into one loan and one easy process, eliminating the stress of not having a permanent loan.
Apply for One Loan
When you apply for a construction-to-permanent loan, you are essentially applying for one loan. This loan will be broken down into two phases, but there is no requalification period or the risk of not having permanent financing. Another difference is that there is only one closing – you sign documents once and are done with the process. With two separate loans, you have to attend two closings and pay closing costs twice in addition to making sure that you are still eligible for the loan. Having one loan is a great advantage of the one step loan for building a home.
Qualifying for the Construction-to-Permanent Loan
When you qualify for the one-step loan, you are essentially qualifying for two loans. The first loan is the loan that will fund the construction of the home, enabling it to be built. The second loan is the permanent loan and the one that will pay off the construction loan. You can think of the construction loan as a short-term loan. It is usually on a very strict timetable. Many lenders have it in the closing documents that the construction much be completed by a certain date in order for financing to go through. This means that the builder must be efficient and very sure of his deadlines to ensure that your financing does not get canceled in the end.
The qualifying portion of the construction-to-permanent loan is very similar to the qualifications for any other loan. You will have to prove your credit worthiness; consistent employment and income; as well as adequate assets and reserves. Most banks will require a down payment of at least 20 percent, but sometimes even more. It depends on whether or not you already own the land which the home is going to be built. If you do not own the land, there is very little collateral for the loan, which makes lenders require a higher down payment to ensure that you really have “skin in the game.” In addition, you will need several months’ worth of reserves for the loan including the principal, interest, taxes, and insurance. Some lenders will also require contingency reserves, which are essentially funds that are reserved for any type of emergencies that arise during the construction phase of the project because you are applying for one loan, you do not have the luxury of altering the amount of the final loan down the road, which means any changes in the future will have to be paid in cash by you.
The payments you make on the construction-to-permanent loan will vary throughout the process. During the building portion of the process, you are only required to pay the interest portion of the loan. The amount you pay will depend on the interest rate at the time, as most construction loans have a variable interest rate and the amount of the funds that have been disbursed to the contractors. This amount will vary for each home depending on the needs of the contractors; the contract that was drawn up; and the requirements of the lender. Some lenders disburse frequently, while others only disburse three times throughout the entire process. Once the construction portion of the process is complete and the final inspection and appraisal have been approved, the permanent loan kicks in. This is the loan that you will pay for the remainder of the term, which is usually between 15 and 30 years. This mortgage is your typical, standard mortgage with standard terms and competitive interest rates. At this point you will pay principal, interest, taxes, and insurance; not just interest payments any longer.
The Strict Timeline
It is important to realize that the construction-to-permanent loan works on a strict timeline. It does not offer a lot of leeway in terms of construction. It is important to ensure that the builder can meet all deadlines that are set forth by the lender with confidence. It is also important to read the fine print on the mortgage as many lenders have the right to cancel financing if the deadlines are not met. You can negotiate wiggle room into the loan, but you need to do so before you get to the closing as you cannot change the terms once the loan is closed. Your switch from construction to permanent financing is contingent upon the appropriate appraisal from a licensed appraiser and final inspection from the lender’s inspector. If things are not in line according to the contract, the financing could be canceled.
The construction-to-permanent loan is a great way to wrap up a complex process into one step. It takes all guesswork out of what type of financing you will be eligible for once the building is complete and ensures you that you will have a home to live in. It also helps you to save time and money in the end as you only have to attend one closing and pay the fees once. While you are a bit more restricted in terms of any changes whether financial or time, if you plan accordingly the one-step loan can be very successful.Click to See the Latest Mortgage Rates»