Having trouble obtaining a loan for construction of a new home? Or a loan to buy a lot where you can build a home? What you can do is opt for a construction to permanent loan that will essentially roll over as your 30 year mortgage. Such a loan will also mean that you pay closing costs only once. Not twice like when you pay to close your construction loan and then your mortgage loan.
Why construction to permanent loan?
Construction loans are not handed out as easily as a mortgage loan? Why? Because a construction loan doesn’t have any collateral. In a mortgage, your home has a value that it can be sold for. With a home under construction, there is no value until it is finished. Just headaches like construction delays, cost overruns etc. This makes lenders reluctant.
While a lender might be reluctant to hand out a construction loan, they are generally more willing when you agree to roll over the construction loan into a 30 year mortgage. This is essentially what a construction to permanent loan is. It is becoming fairly popular.
Advantages of a construction to permanent loan
- Can be used to buy a lot, construct a home and for a mortgage
- Can result in only one closing costs as opposed to 3!
- Only interest payments to be made in the 12 month construction period (Will not reduce principal)
Typical stages of a construction to permanent loan
You will typically be allowed to bring your own chosen builder to construct your new home. But, it is subject to approval by the lender. So, as a first step in securing a construction to a permanent loan, ensure that the lender will be willing to work with the builder that you have chosen.
Appraisal of your future constructed home
Since a construction to permanent loan acts like a mortgage loan, an appraisal of your home will be made as if it is were already finished, in the locality that you have chosen. The appraiser will use your design plans, construction blueprint and then compare it to houses of similar nature, in your chosen locality. Typically, construction to permanent loan amount disbursements will not exceed 80% of the value the house has been appraised for.
Agreement on construction schedule
This is the stage where the builder, you and the lender will sit and decide on a construction schedule. The lender needs a schedule so they can disburse payments accordingly. The builder must provide as accurate an estimate as possible,a construction timeline. Delays here and there are inevitable but the timeline shouldn’t be recklessly not complied to either.
Disbursement of construction funds, after inspection
Once construction begins, the lender will disburse funds in portions, after carrying out inspections to check if construction milestones have been reached, as agreed upon in the construction timeline.
As and when new funds are released for construction, appropriate interest charges will be added to your statement.
Please note that inspections will not factor in quality of work. Rather, it will be about ensuring progress in completion. If you are unhappy with the builder’s work, you may approach local bodies concerned with building regulations or take it up with the builder themselves.
Post Construction stage
This is the stage when your loan essentially becomes a mortgage. At this point, you will incur various fees such as title fees, homeowners insurance and applicable taxes. Once everything is in order, your monthly payment will be adjusted to reflect your principal payments and your prepaid interest payments on your mortgage, just like how it happens with a regular mortgage.
Choosing the right interest rate to lock in your construction to permanent loan
Construction to permanent loans give you the option to lock in an interest rate on your mortgage, even before your house is built. This may be beneficial or not so beneficial, depending on how interest rates change over the time it takes to build your house.
If you think that the interest rate might drop after a year, you might want to think twice about locking in your mortgage interest rate. Paying even a 0.25% higher interest rate on a $100,000 mortgage over 30 years will mean that you pay $15 a month extra. Over 30 years, that adds up to $5,400.
Some construction to permanent loan lenders will give you the option to change your locked-in variable rate after construction and when your mortgage has started, if interest rates have favorably dropped. Ideally, you must make sure that this provision exists.
Some lenders will allow you to do the above, but only if you pay a fee that they charge. Depending on how much it is, it sometimes might not be worth the trouble to change your interest rate at all! Discuss interest rate lock-in scenarios at length before you decide to lock in an interest rate and definitely before you decide to commit to one.
Who can qualify for a construction to permanent loan?
There are certain eligibility requirements for the issuance of these types of loan.
- Home must be a single unit or detached home
- Home must be primary or secondary (vacation) residence
- Loan can be used for new construction, renovation or addition (improvement), even if you are still living in it
What to be wary about when it comes to construction to permanent loans?
Be wary of lenders who try to stack the odds in their favor when deciding on the terms of your construction to permanent loan. Some lenders will promise you a very low interest rate on construction costs, while charging you more than what you should be paying for your mortgage. It makes no sense to enjoy lower interest on construction costs that you pay for just a year and then pay higher interest on your mortgage for the next 30 years. Since your mortgage value will be determined by an appraisal,also be wary of aggressive valuations where the lender estimates your home’s worth as full market value or sometimes, even more than that.
It also wont hurt to explore the cost of obtaining two loans; one to construct the home and one to finance the mortgage. It is not always that savings in closing costs means that you pay for two separate loans, especially if you receive a very favorable financing offer from your builder.