Construction-to-Permanent Loans: How They Work

A construction-to-permanent loan pays for building a home and then turns into a regular long-term mortgage once the house is finished. It can be set up as a single closing, where one approval covers both stages, or as two closings, where a short-term construction loan is replaced by a separate mortgage at the end. Which structure fits depends on your timeline, your land, your builder and how much uncertainty you can live with.

How a construction loan differs from a regular mortgage

A standard mortgage pays the seller in full on closing day for a home that already exists. A construction loan is different. The CFPB describes it as usually a short-term loan used to build or rehabilitate a home, with money provided in a series of advances as construction progresses. Rates on short-term construction financing are generally higher than on longer-term purchase mortgages.

A construction-to-permanent loan connects the two stages. During the build, the lender releases money to the builder in draws. After the home is complete, the balance becomes a long-term mortgage with its own term and payment structure.

Single-close versus two-close

Single-close (one-time close)

The lender underwrites and closes the construction loan and the permanent mortgage together, with one set of closing documents. Fannie Mae points to several borrower benefits of this structure: paying for one closing instead of two, the chance to lock the permanent rate before construction starts, and a single signing appointment.

The tradeoffs: fewer lenders offer it, the project usually has to finish within a set construction window, and the lender will be stricter about the builder, plans and budget up front.

Two-close

You take out a construction loan first. When the home is finished, you apply for a separate mortgage that pays off the construction loan. This gives you more freedom to shop for the permanent mortgage at the end, and it may work with lenders or builders that do not offer single-close loans.

The tradeoffs: two sets of closing costs, two approvals, and the risk that your income, credit or market conditions change before the second closing. If the construction loan does not convert automatically, you may need to apply for a new loan to repay it.

What happens during construction

• Draw schedule. The loan amount is released in stages tied to milestones such as foundation, framing, rough-in and completion. The lender or a third party it hires manages the payouts to the builder.
• Inspections. Before most draws, an inspector confirms the work was done. This protects you and the lender from paying for work that is not finished.
• Interest during the build. Many construction loans charge interest only on the amount drawn so far. Some build interest reserves into the loan. Your Loan Estimate and loan terms explain how this works for your loan.
• Change orders. Changes after closing can affect the budget, the appraisal and the draw schedule. Most lenders want changes approved in writing.

Conversion to the permanent mortgage

Once a final inspection confirms the home is complete and a certificate of occupancy is issued where required, the loan moves to its permanent phase. In a single-close loan, this happens under the documents you already signed, sometimes with a modification if loan terms change. In a two-close loan, it means closing the new mortgage.

If construction takes longer than expected, the lender may need to update your income, employment and credit documents before conversion and confirm you still qualify. Fannie Mae's guidance also notes that a single-close loan that runs past its construction window may need to be restructured as a two-close transaction. Plan for weather, supply and inspection delays when you set your timeline.

The land question

Your lot shapes the loan:

• Buying the lot as part of the project. Some single-close loans can include the land purchase along with construction.
• Already owning the lot. Equity in land you own may count toward the project. Some lenders treat this as a refinance of the land plus construction.
• Owning the lot with a loan on it. The existing land loan is usually paid off at closing.

Lot ownership rules differ between single-close and two-close structures and between loan programs, so bring your deed and any land loan statement to the first conversation.

Loan types that may be available

Construction-to-permanent financing can be offered under several loan types, depending on the lender:

• Conventional. Loans that follow Fannie Mae or Freddie Mac guidelines, including single-close options for site-built and manufactured homes.
• FHA. FHA-insured construction-to-permanent options exist with some lenders, with FHA property standards applying to the finished home.
• VA. Eligible Veterans and service members may use a VA-backed loan to build a home through lenders that offer it.
• USDA. USDA Rural Development lists participating lenders for its single-close construction-to-permanent option in eligible rural areas.
• Jumbo or portfolio. Larger custom builds may use loans held by the lender rather than sold.

Programs vary by borrower, property and investor, and not every lender offers every option.

What lenders typically review

Beyond your own credit, income, assets and debts, a construction lender looks at:

• The builder's license, insurance, track record and finances
• A signed construction contract and detailed budget
• Plans and specifications, which the appraiser uses to estimate the finished value
• The lot, including survey, zoning, utilities and access
• Permits and any homeowners association approvals

Most lenders do not allow you to act as your own general contractor on this type of loan.

Budgeting for the build

The construction budget is the center of the whole loan. The lender compares it with the appraiser's estimate of the finished value and with your income and assets. A few habits help keep it realistic:

• Get a detailed contract. Line items for site work, foundation, framing, systems, finishes and allowances make it easier to spot gaps.
• Watch allowances. Allowances for items like cabinets, flooring and fixtures are placeholders. If your choices cost more, the difference usually comes out of your pocket.
• Ask about site costs. Wells, septic systems, long driveways, tree clearing and utility hookups can be significant on rural or wooded lots.
• Plan a cushion. Many lenders build in a contingency for surprises. Keep some savings of your own available as well.
• Remember living costs. If you are renting or carrying another home during the build, include those costs in your plan.

Rate locks and timing

With a single-close loan, some lenders let you lock the rate for the permanent mortgage before construction begins, which takes market changes out of the picture during the build. Others offer a float-down feature if rates fall before conversion. With a two-close loan, the permanent rate is usually set near the end, when you apply for the second loan. Ask each lender how and when the rate is set, what the lock costs and what happens if construction runs past the lock period.

Is a construction-to-permanent loan right for you?

It may fit if you want a custom home, have land picked out or owned, and have a builder ready with a firm contract. It may not fit if you need to move quickly, are unsure about the budget, or would be stretched if the project ran late.

A loan officer who handles construction loans can compare single-close and two-close options for your situation and explain how each would work with your builder and land.

Frequently asked questions

Next steps

• Construction Loans

Sources

• CFPB: What is a construction loan?
• Fannie Mae: Construction-to-permanent financing
• Fannie Mae: FAQs on construction-to-permanent financing
• USDA Single Family Housing Guaranteed Loan Program
• VA purchase loan