How Does a One-Time Close Construction Loan Work?

A one-time close construction loan offers a streamlined approach for individuals planning to build a new home. This financial product combines financing for both the construction phase and the permanent mortgage into a single transaction. This simplifies the process, providing a unified financial pathway from groundbreaking to move-in.

Defining One-Time Close Construction Loans

A one-time close (OTC) construction loan is a single loan covering both the temporary financing during construction and the long-term mortgage upon completion. Borrowers go through the application and closing process only once, signing all necessary documents upfront. The loan functions as an interest-only construction loan while the home is built, then automatically converts into a principal and interest-bearing permanent mortgage once construction concludes.

This model contrasts with the traditional two-time close approach, which requires separate loans and two distinct closing events. With a two-time close, borrowers secure a construction loan first, then apply for and close on a separate permanent mortgage upon completion. This incurs a second set of closing costs and a second underwriting process. The OTC loan eliminates these additional steps, reducing administrative burden and potentially saving on a second round of closing fees, which can range from 2% to 5% of the loan amount. The automatic conversion also provides stability, as borrowers do not face the risk of not qualifying for the permanent loan after construction is completed.

Borrower and Project Eligibility

Qualifying for a one-time close construction loan requires meeting specific criteria for the borrower and the proposed project. Borrowers need a strong credit profile, with minimum scores often ranging from 620 to 680 or higher, depending on the loan type (e.g., FHA, VA, Conventional). Lenders also assess the borrower’s debt-to-income (DTI) ratio and income stability to ensure repayment capacity, similar to standard mortgage qualifications. Down payment requirements vary, with some programs like FHA OTC loans allowing as little as 3.5% down, while others may require 10% to 20%.

The project property type generally needs to be a single-family home intended as a primary residence, though some programs may accommodate modular or manufactured homes. The chosen builder must be licensed, experienced, and lender-approved, often requiring a review of their credentials and financial standing. Detailed construction plans, specifications, and a comprehensive budget are required to evaluate the project’s feasibility and cost. A construction contingency, typically around 5% of the total cost, is built into the loan to cover unforeseen expenses.

The Application and Closing Process

The process for a one-time close construction loan begins with the application submission, where borrowers provide financial documentation similar to a standard mortgage. This includes income verification, asset statements, and credit history details. Once the application is complete, underwriting commences, involving a thorough review of the borrower’s qualifications and the project’s viability. This stage also includes an appraisal based on the home’s completed value, rather than its current state, and a detailed review of the builder’s contract and plans.

Following successful underwriting, the single closing event takes place before construction begins. At this closing, the borrower signs all legal documents for both the construction phase and the subsequent permanent mortgage. This includes the promissory note, which specifies the terms of the long-term repayment, and the deed of trust. All closing costs, which can include origination fees, title insurance, and recording fees, are typically paid at this time. Funds for construction are not disbursed immediately in full but are made available through a draw schedule as construction progresses.

Managing the Construction Phase

Once the one-time close loan is finalized, managing the home’s construction begins. Funds are disbursed to the builder through a draw schedule, a pre-determined series of payments released as specific construction milestones are achieved. These milestones can include foundation completion, framing, rough-ins for plumbing and electrical, and final completion. Each draw request typically requires an inspection by the lender or a third-party inspector to verify that the work corresponds to the approved plans and that the quality meets established standards.

Should changes to the original plans become necessary, these are handled through formal change orders. These orders must be approved by the borrower, builder, and lender, and may impact the overall project cost and the remaining loan funds. If a change order increases costs beyond the initial budget and contingency, the borrower may be responsible for covering the difference. Throughout construction, clear communication between the borrower, builder, and lender is maintained, often facilitated by a loan servicer who manages draw requests and inspections.

Loan Conversion and Repayment

Upon construction completion, the one-time close loan seamlessly transitions from the interest-only construction phase to the permanent mortgage. This conversion occurs after the local municipality issues a certificate of occupancy, signifying the home is safe and ready for habitation. Lenders may conduct a final inspection to ensure all work is completed according to approved plans and local codes before the loan officially converts. No re-qualification or additional closing is required at this stage, as all terms were established during the initial single closing.

Once converted, the borrower begins making regular principal and interest payments according to agreed-upon terms. These terms typically mirror those of a standard residential mortgage, such as a 15-year or 30-year fixed-rate loan. The interest rate, often locked in at the initial closing, determines the monthly payment amount, providing predictability for the borrower’s long-term financial planning. The transition marks the end of the construction financing period and the beginning of the long-term homeownership repayment.