When building a new home from the ground up, there are two primary choices borrowers have. A construction loan and a construct-to-perm loan. Both are fine choices but they take different paths toward final completion of the new home.
With a standard construction loan, the applicants consult with a local architect and builder. After the blue prints and timeline is prepared, the plans and specifications are handed over to a local lender. The lender will evaluate the documents and make an estimate of the future value of the property once completed. This estimate is provided by an appraiser. For existing homes, the value is referred to “as is” and with construction it’s “as completed.”
If the completed value is appraised at $300,000, the construction loan amount will typically be 80 percent of that amount, or in this example, $240,000. It will be up to the borrowers to provide the down payment of $60,000. If the applicants already own the land, many times the land itself provides enough equity to cover the 20 percent down payment.
The lender prepares a “draw schedule” which lays out how much money will be given to the contractor and when. The contractor does not receive a lump sum payment but paid out in predetermined draws. The initial draw might be for 10 percent of the loan amount to clear the lot. Once the contractor has finished this initial phase, the lender sends out an inspector to verify the lot has been cleared. Once that verification has been made, the lender releases the next set of funds to start with electrical and plumbing. Again, once completed, an inspection is made, confirmed and the next draw is issued.
When the home is declared complete, the lender sends one final inspector to verify the home is ready for occupancy. The construction is completed and the construction loan is due in full. Most construction loans ask for periodic payments from the borrowers during construction while others wait until the very end. To pay off the construction loan, the new homeowners need permanent financing. This can be any type of residential home loan such as VA, FHA, USDA or conventional mortgages.
When first applying for a construction loan, the construction lender wants to see a preapproval letter from a mortgage company if a third party lender is being used. First it’s a construction loan, then it’s a permanent loan. As there are two different loans, there are two different closings to attend, one for the construction and one for the long term financing. Lenders can also ask for an updated approval letter if the initial approval is more than 30-60 days old.
A construct-to-perm loan, often referred to as a “one time close” loan, is both a construction loan and long term financing wrapped into one. That means there is only one loan closing to attend.
This type of loan works just like a standard construction loan while the home is being built as funds are handed out in phases and inspections regularly performed. Yet because the permanent mortgage is already in place, once the final inspection is performed and a certificate of occupancy issued, the permanent mortgage is immediately put in place.