Mortgages are designed as long-term financing for the purchase of a home that is already built, and not for vacant land, lots, or major renovations or rehabilitation projects. If you are buying land and building a home or making significant changes to your existing home, you may need short-term financing for the construction process, and then upon completion, a mortgage for the completed home. This could mean two separate loans, two closings, and the risk of a change in market conditions during the process that could make it harder to finance the completed home.
Alternatively, a construction to permanent loan (sometimes also called a C to P loan) is designed to avoid the need for two separate loans when building a home. It is a single-close loan that starts as a construction loan where money is drawn as needed to pay building costs, then converts to a permanent mortgage upon the completion of the home. The terms for both stages of the loan are set in advance, and you, your bank, and your builder agree to a payment schedule based on certain milestones in the construction phase. During the construction phase of the loan, interest is charged only on the outstanding principal balance of the loan.
When the construction is completed and inspected, the loan automatically converts to a permanent mortgage loan with principal and interest payments due at the previously determined rate. Appraisals and the loan amount are based on the finished property’s value.
How it works:
- Application – The construction to permanent loan application process is the same as that for a mortgage. You may be asked to provide documents including bank statements, proof of income, and tax returns. There will likely be a cash down payment required.
- Cost Estimates – A detailed cost estimate from a licensed contractor which includes “hard costs” such as construction materials and “soft costs” such as incidental fees and services incurred during the home’s construction is also needed in the application process.
- Plans and Specification – A complete set of house plans and specifications of the finishes must be provided so that the appraiser can determine the finished property’s value.
- Time Frame – The construction to permanent loan allows up to a year to complete the building phase.
- After inspection of the work at key points during construction, funds are disbursed.
- Once construction is completed, your financing transitions into a permanent mortgage.
Benefits to construction to permanent financing include:
- One loan and one closing cover both the construction phase and the permanent financing. This streamlines the application process and can minimize closing fees.
- Your rate and loan term are determined in advance.
- Money is available when you need it during the building, according to the disbursement schedule.
- Quick payments – after inspection of the work, funds are generally disbursed within a few days.