Construction Loans

A construction loan finances the building of a home rather than the purchase of an existing one.

When the home is complete, the construction loan either pays off (a “two-time close”) or converts directly into your permanent mortgage (a “one-time close”). Conversion is subject to the loan’s completion and underwriting requirements.

One-time close:

• You close once at the start of construction.
• One construction-to-permanent closing, with conversion subject to the loan’s completion and underwriting requirements. Updated credit, income or appraisal information may still be needed.
• Rate-lock availability, duration, extension costs and any float-down option depend on the program and written lock agreement. Confirm the permanent-financing terms before closing.
• Available construction-to-permanent options can include Conventional, FHA and VA programs, subject to current lender and program requirements. Project and program requirements apply.

Two-time close:

• Separate construction loan, then a second closing to refinance into permanent financing.
• Two sets of closing costs.
• Permanent-financing terms must be confirmed for the separate closing.

The appropriate structure depends on the project, available programs, costs and permanent-financing terms.

Construction financing is not approved from a purchase price alone. The lender needs enough information to understand what is being built, what it will cost, who is building it, how the project will be funded, and what the completed property should be worth.

That generally means a defined set of plans and specifications, a construction contract, a detailed budget, the proposed construction schedule, information about the builder or general contractor, and documentation showing how the lot is being acquired or how land the borrower already owns will be treated in the transaction.

For proposed construction, the appraisal evaluates the property based on its as-completed value, using the plans and specifications for the home that is going to exist when construction is finished.

If the borrower already owns the land, the transaction can be structured differently than when the lot is being purchased at closing. For example, Fannie Mae’s single-closing rules distinguish a lot acquired with the transaction from land the borrower already owns. Land value, acquisition timing and existing liens can affect the transaction classification and equity calculation under those rules; other programs can treat them differently.

The borrower should also have a realistic plan for cost overruns and changes to the project. Additional construction costs do not automatically become additional loan proceeds. Depending on the program, a change may require additional borrower funds, lender approval, documented modification or re-underwriting.

Once the loan closes, construction money is generally released in stages rather than handed to the builder all at once. The lender manages a draw process tied to the construction budget and progress on the home.

As construction reaches agreed milestones, the builder requests funds and the lender verifies the work supporting that draw. The exact inspection schedule, documentation, draw frequency and payment calculation during construction depend on the lender and construction program.

Changes and overruns need to be addressed while the project is underway. Under applicable single-close agency structures, increasing the final mortgage because construction costs increased requires documented support and can require re-underwriting.

At completion, the lender confirms that the home was completed according to the approved plans and applicable property requirements. Depending on the program, that can include a completion inspection or appraisal update, certificate of occupancy or equivalent, title/lien documentation and other final construction records.

The construction phase is therefore a controlled process of draws, inspections, documentation, change management and final completion approval, not simply a period of building followed automatically by the permanent mortgage.