A Construction Permanent Loan is form of a residential financing taken out by a consumer to finance the construction of their custom home.  It is similar to the Construction Loan, but it adds a layer of protection to the consumer by providing a permanent financing option. 

The Construction Permanent Loan provides the short term construction financing which ranges 6 to 12 months in duration and the option to modify into a permanent loan at time of completion.

Like the Construction Loan, they can be used to acquire the land to build upon, unless the consumer already owns the property and finance the actual construction cost to have the house built.  The amount of the loan is based on the cost or value of the land depending on whether the lot is owned prior to application, plus the cost to construct the new dwelling.

Banks will typically lend a percentage of that total which is known as the Loan to Value Ratio.  They disburse the funds necessary to acquire or payoff the lot at closing, less the borrowers required investment / down payment and the balance of the funds are placed into an escrow account for future disbursement as the house is built.

The rates on these loans can be slightly higher than a traditional loan due to the increased level of risk to the financial institution as they are lending against a hypothetical house which has yet to be built as well as the short term nature of these loans.  Many construction permanent loans will have a variable rate of interest tied to the prime rate plus a profit margin or a hybrid Adjustable Rate Mortgage (ARM) where the rate is fixed for the first term of the loan.

These hybrid ARM’s are typically fixed for an initial period of 3, 5, 7, 10 or even 15 years which include the construction period and then adjust annually thereafter based on a an index like the 1 Year London Interbank Offer Rate (Libor) or more recently the Secured Overnight Financing Rate (SOFR) plus a margin. 

Some lenders offer fixed rate construction permanent financing based on a 15 of 30 year fixed rate.  Some of which offer one rate during construction, then a new rate at time of completion. Better options however are via a “True One Time Close” Construction Permanent loan which affords clients the ability to lock in at current market rate which remains the same for the entire term of the loan (construction and permanent phases).

These are much better options for consumers because of the added safety and protection of having a permanent option in place and are often available thru Community Banks.

During the Construction Phase of these loans, clients typically pay very low interest only payments based on the average outstanding balance which is disbursed as the home is being built.

The borrower pays interest payment only on the amounts the bank has actually paid out to their builder from the escrow account associated with their loan.  After the initial disbursement, if necessary at closing, the balance of the funds are placed in escrow with the lender and disbursed to the builder after they have completed a certain progress milestone.  This is known as a draw disbursement.

The builder typically reaches a completion milestone and contacts the bank for a draw against the escrow account.  Most banks contract with an independent qualified building inspector to confirm the work required has been completed in workmanship like manner prior to disbursing funds or payment. Often times the inspector will contact the County, Township or local regulatory agents to validate any inspections required for the local building code have been met prior to sending the inspection report to the lender confirming the progress items being completed.

The bank then disburses the required funds allocated toward that stage of construction to the builder from the escrow account increasing the borrower’s loan balance and the monthly interest payments.  This process continues until time the home is fully completed.

Once the new home has been completed and a final draw inspection has been completed, the builder typically provides proof the local regulatory agencies have approved the new home for occupancy. This comes in the form of a Use and Occupancy Permit / Certificate of Occupancy which confirms the property meets all local codes and is livable by their standards. Once this has been received by the lender, the final draw payment is released and the builder turns over the keys to the homeowner so they may move in and enjoy their amazing new home.

At this time however, unless you have a “True One Time Close” Construction Permanent loan, the lender will require the borrowers to modify the loan to a permanent financing option via a modification process.  Depending on the lender, this can be as simple as signing a few documents certifying completion or a full re-qualification process which can include verification of income, assets and require an updated appraisal.

The “True One Time Close” option is usually the best for most borrowers as there are typically no additional requirements at time of completion for them to complete, other than moving in of course!

As you start preparing to build a new home, getting pre-approved early on can prove very important. Check out my blog post on preparing for loan application to learn more about what you will need to get started.

Check out our Pathway to your new Custom Home for a step by step pictorial guide to the entire process of building a new custom home.