What Is a Construction-to-Perm Loan?

A construction-to-perm loan offers a unified financial solution for individuals seeking to build a new home. This specialized lending product consolidates both the short-term construction financing and the long-term mortgage into a single loan, often referred to as a “one-time close” loan. Its primary purpose is to streamline the financing process, allowing borrowers to secure funding for the construction phase and eventually transition to permanent homeownership without the need for two separate loan applications and closings. This unique structure aims to simplify the journey from raw land or an existing structure to a completed residence, providing financial continuity throughout the project.

Understanding the Construction and Permanent Phases

A construction-to-perm loan is characterized by two distinct phases that manage the funding from groundbreaking to move-in. The initial period is the construction phase, during which funds are disbursed incrementally to cover building costs as the project progresses. During this phase, borrowers typically make interest-only payments on the amount of funds that have been drawn, rather than on the full loan amount. This short-term phase, usually lasting from six months to two years, is designed to align with the building timeline.

Once construction is completed, the loan transitions into its permanent phase, becoming a traditional mortgage. The loan converts to a standard principal and interest payment structure. The permanent phase typically features a longer term, commonly 15 or 30 years, with either a fixed or adjustable interest rate. A key advantage of this combined loan type is the single closing, which means borrowers avoid incurring two sets of closing costs that would be associated with separate construction and permanent loans.

Key Borrower and Project Requirements

Securing a construction-to-perm loan necessitates a thorough preparation of both personal financial information and detailed project documentation. Lenders typically require strong borrower financials, including a solid credit score. A low debt-to-income (DTI) ratio is also important. Borrowers must also demonstrate stable income and employment history, along with sufficient liquid asset reserves for a down payment, commonly ranging from 20% to 25% of the total project cost.

Project documentation is equally crucial, requiring detailed construction plans, blueprints, and specifications for the proposed home. A comprehensive budget outlining both hard costs (materials, labor) and soft costs (architectural fees, permits) is also necessary. Lenders will rigorously vet the chosen builder, assessing their license, insurance, experience, and references from past clients and trade partners. The builder’s financial stability may also be evaluated, as their track record directly impacts the project’s success. Information about the land, including permits, must also be provided to the lender.

The Application and Construction Funding Process

The application for a construction-to-perm loan involves submitting documentation to the lender for an underwriting review. The appraisal is based on the estimated completed value of the home, rather than its current state. Once the underwriting is complete and the loan is approved, the borrower receives a loan commitment.

During the construction phase, funds are not disbursed as a lump sum but are released through a series of “draws” tied to specific project milestones. These milestones might include the completion of the foundation, framing, roofing, or other significant stages of construction. Before each draw is released, the lender usually conducts inspections to verify that the work has been completed according to the agreed-upon plans and budget. Interest payments during construction are calculated only on the amount of funds that have been drawn, meaning payments increase as more funds are released and the project progresses.

Converting to Permanent Financing

Upon completion of the home, the loan transitions from the construction phase to its permanent mortgage status. This transition requires a final inspection by the lender to confirm construction adheres to approved plans. A Certificate of Occupancy (CO) is also required, issued by local authorities, certifying the building is safe and compliant with codes.

For a one-time close loan, this conversion is facilitated through a loan modification agreement. This agreement formally adjusts the terms of the existing loan to reflect the permanent financing, including the final interest rate, which may have been locked in at the initial closing, and the new payment schedule. The loan is then re-amortized, shifting from interest-only payments to a schedule that includes both principal and interest. The first full principal and interest payment typically becomes due shortly after this conversion, marking the beginning of the long-term repayment period.