What Is a Construction-to-Permanent Loan?

A construction-to-permanent loan is a type of mortgage you can use to finance both the building and the purchase of a new home. You can potentially save money on closing costs and avoid underwriting complications when you use one of these loans to finance your new house. However, these loans also have some downsides that include inflexible rate options.

You can't use a conventional mortgage to buy a patch of land or a semi-built home. Many people take out a short-term loan to finance these costs and then apply for an actual mortgage once the home is complete. When you do this, you could run into problems if your credit score or income level drops after you start building your home. You might finish building your home only to find that you can't qualify for the mortgage you were planning to use to pay off the short-term loan.

With a construction-to-permanent loan, the two loans are rolled into one. This means you don't have to requalify for the actual mortgage after the home has been built.

Your lender releases cash to the builder to fund each phase of the construction. You may also use some of the loan proceeds to buy the land you intend to build your home on.

During the building phase, you may have the option of making interest-only payments. You usually pay a variable rate of interest during this phase but you can switch to a fixed interest rate once your home has been built. At this time, your construction loan rolls into a standard 15- or 30-year mortgage.

Mortgage interest rates change on a daily basis, and these are affected by the real estate market and the economy as a whole. When you take out a construction-to-permanent loan, you only attend one loan closing. This means you have to lock in the interest rate for the actual mortgage before you've even started to build your home.

It could take a year or more for construction to reach completion and by that time interest rates for loans may be much lower. Some people view the rate lock as one of the negatives of construction-to-permanent loans. However, interest rates could just as easily rise after you sign your loan agreement, so the rate lock could work in your favor.

Construction-to-permanent loan agreements include strict timelines for the building phase. Your lender may have the option to cancel the loan if building delays or other issues prevent you from meeting the construction deadline. Once the home has been built, a licensed real estate appraiser has to inspect your home to ensure the builders didn't deviate from the blueprints your lender approved. Assuming everything is in order, then your actual mortgage agreement comes into effect.