This loan has one rate and one closing for the construction and the permanent mortgage. The loan can be used to finance the purchase of the property and the construction costs. If the property is already owned, any equity created when the construction is complete can be used toward the total equity to finance the transaction, effectively creating a 100% financing option. During the typical 12 month construction phase interest-only payments are made on the funds advanced to pay for the construction. A loan disbursement worksheet is set up prior to closing so both the borrower and builder will know how the construction will be funded. When the home is built the construction loan converts to a 30 fixed rate mortgage.
Depending on the borrower’s needs, the interest rate on this loan gets set and locked-in either at time of application or prior to closing. There is one rate for both the construction phase and permanent mortgage. During construction, interest only monthly payments are made on the outstanding principal balance. The balance on the construction loan will increase as draws are taken out to pay for the construction. When the construction is finished and the certificate of occupancy is issued the loan converts to a permanent mortgage at the same rate the borrower received when they closed the loan.
At application, the borrower will need to provide a signed construction contract and budget, signed property purchase contract, if applicable and a set of building plans. Building permits are not needed to apply but will be required before any actual construction may begin.
Because of the lengthy time frame involved with construction, up to a year or even longer in some cases, there are special considerations when it comes to construction financing. Each Construction to Permanent mortgage is structured to meet the borrower’s specific needs. Being prepared to make the transition financially and physically while a home is being built or undergoing major renovation can require some juggling and careful planning.
If the borrower wants to wait to sell their current home until the new home is ready to move in, they must qualify for the new construction loan while still making payments on their existing home even if it’s listed for sale but has not closed. Borrowers who cannot qualify this way may need to consider selling their current home before construction begins and temporarily rent or live with family until the new home is ready.
On a construction purchase transaction, the borrower must put down at least 20% of the total acquisition cost, i.e. the combination of the property contract and construction contract. The lender will typically finance up to 80% of this amount. Construction costs are generally categorized as “hard costs” and “soft costs.” The materials and labor are hard costs and things like design plans, architectural drawings, engineering fees, permits, etc. are soft costs. Some soft costs can be financed if they are included in the construction contract.
The borrower may need the proceeds from the sale of their current home to help with the down payment on their new home. If that’s the case they’ll need to sell before they close their construction to permanent mortgage. In addition to the down payment the borrower will need money for closing costs and reserves. With only one loan needed for both construction and permanent mortgage, closing costs are much less than when two separate loans are used to finance the project.
The borrower must also have additional funds on hand to cover any potential cost overruns and may need reserves to cover certain housing expenses during the construction phase. The reserve requirements depend on the transaction and are calculated by the lender before the loan is approved so the borrower is prepared upfront for what is needed.
Building a new home or doing a major renovation can be a complex process. A one-time close construction to permanent mortgage makes the financing simple. The borrower can focus their energy and time on their project with peace of mind knowing both the construction financing and the mortgage are approved, the rate is set and the details for financing each stage from start to finish have been worked out ahead of time.
ABOUT: Arthur Aranda has over 25 years of mortgage banking experience and works extensively with home builders and homeowners on financing home construction and renovation projects. Aranda is also a Certified Financial Education Instructor and provides First Time Homebuyer Seminars. For more information on construction loans or to schedule a FTHB seminar please call Arthur Aranda at 201-741-1537.