BUILD YOUR DREAM HOME IN 6 EASY STEPS
A Construction to Permanent Loan1 gives you the opportunity to work with an architect and contractor to build the home you want, using financing. With this loan, you may be able build your dream home from the ground up.
Defining a Construction to Permanent Loan
A Construction to Permanent Loan finances new construction of a home in one loan, so that the process of working with a contractor and a lender is streamlined. You lock in your interest rate at the outset of construction — not when the home is completed. You also get the financial flexibility to afford building your new home while living in your current one.
Who Qualifies for a Construction to Permanent Loan?
If you are considering a Construction to Permanent Loan, talk with several banks, to make sure you are preapproved. Typically, banks require higher credit scores (700 or higher), more money down (20%-30% minimum), a lower debt-to-income ratio (maximum of approximately 40%), and higher reserves (often 12 months or more) for this type of loan, as compared to a conventional mortgage.
However, these qualifications do vary. For example, at First Midwest Bank, borrowers in certain situations may be able to put down as little as 10% on a Construction to Permanent Loan.1
Best Practices for a Construction to Permanent Loan
Once you are preapproved, the first step is identifying a builder to execute your plan and developing blueprints with an architect. Often lenders have a list of contractors and builders who they have partnered with previously on a Construction to Permanent project; it makes sense to work with your lender as you select a contractor.
You want the blueprints to follow your local building code to the letter, since they will be vetted in detail by your lender. Similarly, you want a builder who has a long track record of high quality, reliable work, who can withstand the scrutiny of your lender. Your builder will then go through a bidding process, to price out the cost of the construction.
“You also need to consider the land cost, and the land value,” said Andrew Trasatt, a Residential Lender with First Midwest Bank. “Are you building on land you already own, or that you intend to buy? Does that purchase need to be built into the process? Your lender can help with this.”
The second step is taking your plans to a lender, so they can be reviewed and approved for financing. This will include a construction contract that outlines the costs of each stage of the build, along with the total costs of the project. The viability of your project will be assessed, as well as the estimated value of the completed home. You (as a borrower) will also be vetted. Lenders typically look at your credit score, income, debt, and savings when considering extending a loan.
While this stage may seem challenging, it offers you peace of mind. Each aspect of your plan is thoroughly tested for its soundness. That means that when you start to build, you know no corners have been cut and that you can proceed with confidence.
What Are Current Construction Loan Rates?
The rate you are offered will depend on a variety of factors, including your credit score, the location and size of the home you want to build, and the broader interest rate environment. If you want to learn the rate you would be offered, you need to talk to a lender.
If you want to ballpark it, a good rule of thumb is that interest rates for Construction to Permanent Loans run a bit higher than a conventional mortgage of the same size and term. This premium is the result of the additional risk a bank takes on when it accepts a yet-to-be-built home as collateral.
However, this slight premium is often worth it. The alternative is a two loan process, with two closings: one for the construction loan, and one for a conventional mortgage once the home is complete. This would mean two sets of closing fees. It also adds stress and uncertainty, since the borrower is relying on the real estate market and interest rates staying favorable until the end of construction in order to get their desired rate.
How is a Construction to Permanent Loan Different?
In contrast to a construction loan, a Construction to Permanent Loan allows you to lock in a rate that lasts throughout the life of the loan, even as it converts to a traditional mortgage. And you only have one closing, at the beginning of the project.
A Construction to Permanent Loan works like this: after your loan is approved and closed, you start construction on your new home. Your lender pays your builder directly, in stages. These payments are called draws, and they reflect the money needed to complete a given portion of construction. For example, a builder may receive 10% of funds initially, which are earmarked for the completion of the foundation. Once that has been completed and inspected, the builder then receives a second draw of 15% of funds to put up the frame of the house, and so on.
Throughout the building phase, you and your lender are working with the builder to make sure every step is done well and on time. Should costs or pricing change, you work together to put through change orders. During this time, you are only paying interest to your lender. This gives you the financial flexibility to afford building your new home while living in your current one.
Once your new home is complete, your loan converts to a traditional mortgage. You avoid the hassle and fees of a second closing. And your rate stays the same – what you agreed upon at the outset. As your loan converts to a traditional mortgage, your monthly payment reflects principal, interest, and escrow. Your mortgage term is typically 30 years, though shorter terms are often available.
Best Banks for Construction to Permanent Loans
Experience matters when considering the best bank for a Construction to Permanent Loan. These loans are complex and require you to work with your lender throughout the duration of the construction phase. You want a lender who knows what they’re doing and who is organized.
“This is an incredibly fluid process,” said Andrew Trasatt, a Residential Lender with First Midwest Bank who has substantial Construction to Permanent experience. “Unlike a traditional mortgage, this is not a static transaction. From the bidding and contract signing, through to change orders during the construction itself, there a lot of moving parts. You need a lender who understands the scope of the project, and is with you every step of the way.”
You also need to consider the terms and rates, and whether a given lender offers financing for the type of home you want to build. For example, First Midwest Bank offers Construction to Permanent Loans for detached primary residences, but also for second homes and two-unit primary residences.
To find the best bank, call a few lenders and see what they have to offer. Compare rates and ask how many Construction to Permanent Loans they do in a year. Remember, service and attention to detail truly matter for this type of loan, so it pays to do your due diligence. After all, you are building your dream home.