Conventional mortgage loans are great for financing a house that already exists, but what if you want to buy land and have your home built from scratch? An all-in-one construction loan, also known as a single closing or construction-to-permanent loan, may be the best way to finance your ideal home in your ideal location with just one mortgage loan.
How Does an All-in-One Construction Loan Work?
An all-in-one construction loan is perfect for you if you’ve found the land you want, prepared your construction plan, and are ready to start working with a builder. If you’ve found the right lot but you’re not quite ready to build, you’ll want some form of lot or land loan instead. An all-in-one construction loan allows you to finance the purchase of land and the construction of your custom home at the same time. It enables you to get approved for two loans simultaneously. An all-in-one construction loan turns into a traditional mortgage loan once your home is complete.
Advantages of an All-in-One Construction Loan
There are several advantages to getting an all-in-one construction loan versus two separate loans:
- One application: You only need to fill out a single loan application for the lot and the construction.
- One closing cost payment: You pay closing costs for both the land and the home as a one-time fee.
- Peace of mind: An all-in-one construction loan allows you to secure financing for the construction well before it starts. It eliminates the anxiety-filled waiting period between buying land and obtaining financing to build on it.
- Locked interest rates: Securing two loans at the same time at a single interest rate ensures that you don’t pay a higher interest rate for construction than you do for the land.
How Construction Loans Are Different from Traditional Mortgage Loans
Construction loans are different from traditional mortgage loans because they have shorter terms (typically 12 months) and are funded in periodic advances, or draws. After each phase of construction is complete, the lender will send out an inspector to ensure the promised work is complete. If everything looks right, the disbursement will go to the builder or contractor to pay them for their work. During the home construction period, you will make interest-only payments. Once the home build is complete, the initial construction loan will automatically convert to a permanent, long-term mortgage with the interest rate you locked in at closing.
How Do You Get Approved for an All-in-One Construction Loan?
To get approved for an all-in-one construction loan, you will need to meet all of the typical underwriting requirements:
- Good credit score
- Low debt-to-income ratio
- Money for a down payment
Plus, you will need to provide a plan for how exactly you intend to complete the home build.
Construction loans are sometimes referred to as “story loans” because the lender wants to know your story and vision for the project. Most lenders require you to:
- Work with an experienced builder
- Provide a construction schedule
- Outline estimated costs for everything
- Give assurances that the structure will meet any local codes and requirements
Although it is possible to build the home yourself, most lenders will be hesitant to approve loans for owner-builders unless you have sufficient contracting or building experience. Lenders want to see that you’re working with a builder who has a good reputation, so they can be confident the home will be properly built with minimal delays.
Which Loan Is Best for First-Time Homebuyers?
All-in-one construction loans often have a higher barrier to entry than a conventional mortgage, because many lenders require down payments of 20-30 percent. First-time homebuyers without substantial savings who are interested in a construction loan might consider a government-backed mortgage, such as:
- An FHA one-time close construction mortgage finances the construction and land purchase for a single-family primary residence with a minimum down payment of 3.5 percent. The loan converts to a permanent mortgage when the build is complete.
- A USDA construction-to-permanent loan offers 100 percent financing with no cash down payment for the land purchase and home construction on property located in designated rural areas. Borrowers must meet the same eligibility requirements as those for a standard USDA purchase loan.
- VA construction loans aren’t as streamlined as FHA and USDA construction-to-permanent loans, but it is possible to use your VA loan entitlement to purchase a new construction home. A more common practice might be to take out a regular short-term construction loan from a lender and have that loan converted to a permanent VA mortgage once the build is complete.
In addition to these federal programs, many states offer grants for building a new home and tax concessions, especially for first-time homebuyers.
Take the Next Step Toward Building Your New Home
Regardless of how you decide to finance your new home’s construction, an excellent first step is getting prequalified for a loan. Chat with a loan officer today to get an idea of your options and plan to build the home of your dreams.