If you intend to build a home on your land, you should explore your financing options. Many borrowers select construction-to-permanent financing since these loans convert to traditional mortgages once construction is complete.
Combining a construction loan with a conventional mortgage is more efficient than applying for both loans separately and provides financial benefits as well.
We are going to explore the key financial advantages of construction-to-permanent loans. While the exact amount you can save depends on your loan agreement, this will give you a better idea of the monetary benefits.
Only Pay Closing Costs Once
If you obtain construction-only financing and then apply for a traditional mortgage, you must close on both loans separately. First, you will close on the construction-only loan, pay the closing costs, and then repeat the process when it’s time to move into the house.
On average, Maryland residents pay $14,721 for closing costs, so paying twice can be quite costly. You can avoid paying a second set of closing costs by choosing construction-to-permanent financing.
Since you will not have to apply for a traditional mortgage, you will only pay to close one time on the construction-to-permanent loan.
Lock in Interest Rates
Although there have been some dips, mortgage rates have consistently increased from 2021-2023. Often, the rates increase monthly, making construction-to-permanent loans attractive to many people.
With construction-to-permanent financing, borrowers lock in the interest rate for the duration of the loan. They receive the same interest rate during construction and throughout the mortgage, allowing them to avoid rate increases.
The rate for a construction-to-permanent loan is typically around 1% higher than the rate for traditional mortgages. However, locking in the rate and avoiding closing fees offsets the higher interest rate.
Easy Budgeting With Interest-Only Payments
Generally, borrowers only make interest payments until construction is complete with construction-to-permanent financing. Additionally, borrowers only pay interest on the amount dispersed to contractors instead of on the entire amount financed.
For example, assume the lender approves a $200,000 construction-to-permanent loan, and the bank disperses $10,000 of the funds the first month. The borrower would only pay interest on the $10,000 for that month. This makes it much easier for borrowers to budget during construction.
Mortgage Payments Without Financial Surprises
At the end of a construction-only loan, borrowers must either repay the balance or apply for a traditional mortgage. Unfortunately, mortgage approval after construction is not guaranteed.
Factors such as a change in income or employment status can make it difficult to get approved, creating significant challenges for some borrowers. Increased interest rates can also decrease the borrowing power previously held at the time of the construction loan creating a deficit that must be balanced by out of pocket funds.
Borrowers can avoid that financial uncertainty by choosing construction-to-permanent financing. With this method, borrowers do not have to repay the construction loan once the project is complete.
Instead, they make monthly mortgage payments based on the agreed-upon terms when closing the loan. They do not have any surprises when transitioning into a mortgage, ensuring they can manage the payments.
Financial Considerations When Applying for a Construction-to-Permanent Loan
While construction-to-permanent loans provide numerous financial advantages, there are also some considerations. First, lenders assume more risk since they cannot use an existing home as collateral.
As a result, most lenders require a 20% down payment before approving the loan unless the borrower owns the land outright and uses it for collateral. Additionally, lenders typically only approve construction-to-permanent loans for borrowers in good financial standing.
You will need a high credit score and a low debt-to-income ratio to get approved. While the debt-to-income ratio requirement varies, lenders typically only approve borrowers with credit scores of 680 or higher.
Borrowers on the low end of that requirement can expect to pay higher interest rates than better-qualified applicants. Of course, this is true for all loans, not just construction-to-permanent financing.
Steps for Getting a Construction-to-Permanent Loan
You must own or find the land you want to purchase before obtaining a loan. Next, you will need to choose a licensed builder to develop the budget and plans.
After entering into a contract with the builder, gather all the financial information required by your institution. At a minimum, you will need to provide proof of employment and income. Once the required documents are in order, you can contact a lender to start the approval process.
Your lender will review all the plans and will likely require an estimated property appraisal. If approved, you can access the funds needed to pay construction expenses.
Take the Next Step to Secure Construction-to-Permanent Financing
Choosing the appropriate loan is an important foundation for your financial health today and into the future. As a community bank, Woodsboro Bank understands your concerns and is available to guide you on the path toward the right financial product.
Contact Woodsboro Bank today to discuss your upcoming construction project. We can evaluate your situation against various products, including construction-to-permanent loans. With our one-on-one assistance, you can make the best decision for your finances and goals.