While construction loan financing can be used in a number of different scenarios, the most popular option is the Construction-to-Permanent Loan. You can use this financing to purchase a lot, build a home and then acquire permanent financing, a true “all-in-one” loan. Not only do you lock in your interest rate but you also potentially save thousands of dollars in title, escrow, appraisal and lender fees.
Often, one acquires a lot, then seeks a construction loan and finally acquires a final “take out” or permanent long term loan. The Construction-to-Perm loan achieves this all with one loan and one set of fees. The interest on the construction portion of the loan is generally interest only, paid on the portion of the loan funds being used. These interest only payments can be folded into the base loan so that there are no out of pocket payments during construction. Avoiding double payments does make it easier to afford your mortgage or rent payments on your current housing while building your new home.
Upon the completion of construction your loan automatically “rolls into” your selected 10, 15 or 30 year take out loan. Only then will you begin making your fully amortized mortgage payments. In other words, you already have locked in your permanent loan. What about the rate on your permanent loan? You will have already locked in your 10, 15 or 30 year take-out rate back at the beginning of the construction loan rather than being at the mercy of potentially higher rates when you are ready for your permanent financing.
Sound too good to be true? As in all things, there are some considerations. Here are a few:
- If you wish to buy a lot, this financing can help purchase the lot while providing the funds with which to build. In most purely lot loans, the maximum Loan-to-Value is 60%, meaning you would need 40 % down payment to purchase. If, on the other hand, you already own a lot with a mortgage balance, this loan can pay off the remaining loan balance and allow you to build. (see subordination agreement comment below)
- If you believe that long term mortgage rates will decline during your construction period, you can choose not to lock in a rate on the permanent portion of your loan. This is called “floating the market”. Remember, once you’ve made the decision to risk
the market rates, you can’t change your mind mid-stream but are then committed to waiting until construction is completed to acquire and lock in the rate on your permanent financing.
- You are free to acquire your permanent loan with another lender by floating the market rate (as mentioned above). Expect the construction lender to require that you be pre-approved for your take-out financing before acquiring the construction loan. After all, the lender will want reassurance that you can pay off the construction loan when the building is completed.
- You will need plans with which to acquire an appraisal and loan approval. An appraiser determines, from your plans, what the value will be when construction is completed. This figure determines the amount and terms of your take-out financing.
Subordination Agreement: Subordination Agreement: If you purchase your lot or land parcel separately and finance it (i.e.; via the seller carrying the note) a subordination agreement should be exercised at the time of the purchase. Such an agreement indicates that the person or entity providing the land financing will voluntarily allow the encumbrance to become secondary financing, allowing any new construction loan to become the primary encumbrance. Without such agreement, the acquisition of construction financing could become problematic.
There is a lot to know when considering construction financing. If you have additional questions, please call us at Humboldt Home Loans where you will always Experience Excellence.