Financial Information

Pros & Cons of a Construction to Permanent Loan

Construction to permanent loans are often used by potential homeowners purchasing land and building their own homes or purchasing modular homes. Construction to permanent loans are a very popular method of financing for people who are building a home or having a home built because they're not making large mortgage payments before they even have their home. Below is an overview of construction to permanent loans and the pros and cons of this method of financing.

A construction to permanent loan is a type of financing where you only get the amount you need to have your home built while it's being built. You draw funds from the loan as the money is needed by the seller or contractor. While the home is still being built, the loan is a construction loan and you only make interest payments. Similar to lines of credit, construction to permanent loans typically go from three months to a year. When your home is all built and set up on your lot, your lender will convert the loan to a permanent mortgage loan.

Pros of Construction to Permanent Loan

  • More flexibility - Because you're not choosing a specific home builder in a specific neighborhood, you have a choice of where you want to build and what contractors you want to use. You also have the flexibility to purchase your lot and build a home with the same financing.
  • Smaller monthly payments - Because you're only making the interest payments on the loan, your payments will be substantially lower. This can be very beneficial if the construction is taking longer than anticipated.
  • Not paying on a home that you're not living in. You aren't expected to make a full mortgage payment until the house is complete. This can be a real advantage because it could become a real financial burden if you're expected to make a large mortgage payment on your new home and continue to pay rent on the home in which you're currently living.
  • Complete package - Construction to permanent loans often include the price of not only the home but also the land on which it will be built.
  • One-time close possible - Some banks and lenders may offer you a one-time close which can save thousands of dollars on fees.

Cons of Construction to Permanent Loan

  • Higher interest - Despite the historically lower interest rates lenders are now charging homebuyers, borrowers typically pay a higher rate of interest during the construction phase of the loan. Some banks may continue to charge the same interest rate after the loan is converted to a permanent mortgage loan.
  • Higher monthly mortgage payments - When you initially got the loan, that time or month became the beginning of your loan term (20, 25 or 30 years). Those months of making just interest payments during the construction are now added to the permanent loan, increasing your monthly payments slightly.
  • Costs may be higher than anticipated. When you purchase a house already built, it is what it is. When you're building a home, it takes months, and you may change your mind on what you actually want in the home, which can increase the cost. For instance, you suddenly discover you really want the oak cupboards as opposed to the cheaper cabinets that were on sale.
  • More upfront money requirements - Construction to permanent loans are usually stricter in terms of requirements such as down payment. This may limit your financial options.
  • Possible additional costs for duplicate services - Many lenders require an appraisal at the site where the home will be and another appraisal when the home is completed. This cost is the buyer's responsibility. Although this is rare, you may also end up paying two sets of closing costs.
  • Possible penalties for delays - Construction loans are generally for a specific amount of time. If there are delays and the house takes longer to build, you may have to pay penalties.

Keep in mind, however, that each lender is different. Although construction loans are very similar in nature from one bank to the next, lenders may vary slightly in how they do business. What you might find at one bank may not necessarily be the case at the next. You'll be making mortgage payments for a long time so shop around for the best deal.