When you combine a permanent fixed rate mortgage with a short term home construction loan you get a hybrid loan package that may fit your client’s needs perfectly. A Construction-Permanent Mortgage can finance both a home purchase and any construction or renovation costs, including a total knock-down. For homes already owned, equity created by the renovation can be applied to the total equity needed to finance the loan, effectively creating a no-down payment option. During the construction phase interest-only payments are made on the funds advanced to pay for the construction. A loan Disbursement Schedule is set up prior to closing so the borrower and builder will know how the payments will be made during construction. When the construction is done the interest-only loan converts to an amortizing 30 year fixed rate mortgage.
The rate on a Construction to Permanent mortgage can be locked at application for 60 days or longer if needed. The rate stays the same when the loan converts to a permanent mortgage.
To apply, your client will need a 1) signed construction contract & cost breakdown with the contractor, 2) a signed property purchase contract and 3) a set of building specs & plans. Permits are not needed to apply but will be required before construction may begin.
Because of the lengthy time frame involved with construction, up to a year 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 waits 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. 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.
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 construction-to permanent mortgage can cover up to 80% of this 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 into 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. During the pre-qualifying interview 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. Your client 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 has been worked out ahead of time.