Construction to Perm – Construction Financing

What is Construction to Perm Financing?

A construction to permanent (or “ construction to perm ”) financing arrangement is the traditional form for financing a newly constructed home. With this form of financing there are two closings in three stages: the “pre-approval” stage, the “interim lending” phase, and the “permanent loan” phase.

Phase 1. The first phase in this arrangement is to obtain approval for a permanent mortgage loan. This process is similar to pre-approval for financing on a standard purchase transaction.  The borrower makes application and submits all of the required documentation to a permanent lender to obtain permanent loan approval. An appraisal report for the proposed residence is prepared “subject to completion of improvements”. The appraiser will obtain the architectural plans, construction documents and specifications of materials, and based on this information the appraiser will state an opinion as to the value of the home once the improvements are completed. Based on all this documentation the permanent mortgage lender will then approve the application and provide a “commitment letter”. The commitment states that the borrower satisfies the conditions for the permanent mortgage loan that will “take out” the interim construction loan once the home is built.  This commitment assures the interim lender that the borrower has the ability to pay the interim loan in full from the proceeds of a new permanent mortgage after construction of the dwelling is completed.

Phase 2. In the second phase the borrower obtains a temporary “interim” or “construction” loan for the purpose of providing funds to acquire the land or lot on which the house is to be erected and to provide the funds necessary to construct the home. If the borrower already owns the land or lot on which the home will be erected, the interim lender (usually a bank) will provide funds to pay-off the balance of any loan secured by a lien on the lot or land. The interim lender will also provide the funds necessary to construct the home.  The interim lender will not disburse all of the funds to the builder or the borrower at the closing. Instead, the interim lender will disburse those funds periodically throughout the period of construction as various phases of construction are completed. The disbursement of a portion of the total interim loan funds as construction progresses is referred to as a “draw”.  There may be as few as three (3) and as many as six (6) draws throughout the construction of improvements.  The borrower pays interest only on the disbursed portion of the loan proceeds.  An interim loan may be either a fixed-rate or variable-rate loan (usually tied to the prime rate).  The interim lender usually requires the borrower to pay the interim interest monthly or quarterly as it accrues during the period of construction, however, in some cases the interim lender may permit the interest to accrue, not requiring its payment until the interim loan is paid in full.

Phase 3. As the completion of the interim construction phase draws near, the permanent lender will update its mortgage loan file obtaining updated credit, income and asset documentation to obtain an updated loan approval for the borrower.  Once the construction of the dwelling is complete, the appraiser that prepared the original written appraisal report will inspect the property to determine that the construction of the dwelling conforms to the plans and specification on which the original opinion of value was based. The title documents are also updated during this process and when completed, the borrower will close on the new permanent mortgage, the proceeds of which will be used to pay the balance on the interim construction loan.

Advantages of a traditional construction to perm financing format

Although most banks and lenders offering a traditional construction to perm will require the borrower to bring a cash to the interim loan closing equivalent to 20% of the project cost (land acquisition cost plus documented cost of construction) the permanent loan will be underwritten and priced based on the appraised value of the completed home. Thus, if the property will appraise for slightly more than the project cost the borrower will receive slightly better pricing based on the lower loan to value ratio created by utilizing the appraised value. This pricing difference will be more dramatic on transactions where the borrower has a lower credit score.

Here is an an example: Let presume a borrower with a 660 credit score acquires a lot for $40,000 and the cost of constructing the propose home is $160,000. The property will appraise for $228,000. Most banks offering a traditional construction to perm format will lend up to 80% of the project cost, $160,000 (80% of $200,000). Yet when underwriting the loan the lender can utilize the appraised value for determining the rate and pricing. On a one time close transaction the lender would utilize the lesser of the project cost and appraised value to determine the loan to value ratio. In this example, the borrower with a 660 credit score would have a credit score pricing adjustment of 2.750 discount points ($5,500). The lender utilizing a traditional two-closing construction to perm format will use the appraised value to determine the loan to value ratio on the permanent loan. Thus, the LTV ratio for the traditional construction to perm will be 70% (because $160,000 is 70% of the appraised value of $228,000). The pricing adjustment for the permanent mortgage utilizing the traditional construction to perm format with a 70% loan to value ratio is only 1 discount point ($2,000). So by utilizing a two-closing construction to perm format, the borrower with the property that appraises for more than project cost will save $3,500 compared to the exact same scenario with a one time close format.

Does the borrower have to qualify twice?

Yes. But although this is touted as an advantage for a one time close by those that offer it, the borrower’s ability to qualify a single time prior to construction on a one time close transaction is only available when the borrower brings at least 30% of the project cost to closing and where the borrower has a median credit score of 700 or higher. Thus the one time close is typically only available to borrowers meeting these rather stringent underwriting requirements.

AmeriFund’s Texas 2-Step – Up to 100% Financing

Here at AMERIFUND, we decided we could improve on the traditional construction to perm format and take the one time close a step farther (pardon the pun) with our Texas 2-Step for new construction. This is the same great program we’ve offered for years that enables investors to acquire investment properties with zero cash outlay. It enables a borrower to do a new construction project with little or no cash if property appraises for more than the project cost. Check out the advantages of this unique program here.

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