A Realtor Guide to a Better Home Construction Loan


Guiding your client through the purchase of a home that needs a lot of renovation work can be daunting. A One-Time Close Construction to Permanent Mortgage may be the best way to finance both the purchase and the renovations. Your client gets a mortgage they need to buy their home and the funds to pay for the renovations.

This hi-bred combination of a mortgage with a short-term home construction loan is a complete loan package that may fit your client’s needs perfectly. A construction to permanent mortgage can also finance the purchase of a total knock-down. For homes already owned or recently purchased, the future equity created from the renovation can be used to finance the loan, effectively creating a no-down payment option. During the construction phase interest-only payments are made on the funds as they are advanced to pay for the construction. This saves money by not paying interest right away on the entire loan amount .  A draw schedule is set up prior to closing so the borrower and builder will know upfront how the payments will be made during construction. When the construction is complete the interest-only loan converts to a permanent amortizing fixed rate mortgage.

The interest rate gets locked at application and is very competitive when compared to standard fixed rate mortgages. When the renovations are complete, up to a year later, the construction loan converts to a mortgage at the same interest rate locked in at application.

To start an application, your client will need a 1) signed property purchase contract, 2) a construction contract with cost breakdown and 3) a set of building plans. Permits are not needed to apply but will be required before any actual construction may begin.

Because of the lengthy time frame involved with some renovations there are special financing considerations. 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 undergoing major renovation can require some juggling and careful planning.

If the borrower waits to sell their current home until the new home is ready to move in, they must qualify for the new construction to permanent mortgage while still making payments on their existing home even if it’s listed for sale but has not closed. If the borrower cannot qualify this way, they may need to consider selling their current home before construction begins and temporarily rent or live with family until the new home is ready.

A minimum of 20% cash of the total acquisition cost, i.e. the property purchase contract plus construction contract is required. The construction to permanent mortgage can cover up to 80% of this “Total Acquisition” amount. Construction costs are generally categorized as   “hard costs” and “soft costs.” Construction 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 cost breakdown.

The borrower may need the proceeds from the sale of their current home to help with their down payment on the new home. If that’s the case they’ll need to sell before they close on their construction to permanent mortgage.  In addition to the down payment the borrower may need money for closing costs. 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.

There is a little more to it than this. During the pre-qualifying interview my job is to make sure the homeowner is qualified for the loan and aware of all costs and lender requirements connected to the financing. Then, together we review the process from application to closing and then how the construction actually gets funded. The beauty of this loan program is the homeowner’s peace of mind from knowing the funds for the construction will be included in the permanent mortgage, the interest rate has been locked-in upfront and all details of financing each stage of the renovation from start to finish has been worked out ahead of time.

ABOUT:  Arthur Aranda NMLS #1042093 has been in the mortgage business since 1986. He specializes in financing new home construction & renovation. Arthur is also a Certified Financial Education Instructor and provides First Time Home Buyer Seminars.  For more information on a construction loan or to schedule a FTHB seminar call Arthur Aranda at 201-741-1537.