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One Time Close Construction Financing
The “ One Time Close ”
A “ one time close ” financing arrangement for construction financing combines the foregoing three phases into a single combined process. With the “ one time close ” transaction the borrower obtains permanent loan approval and closes the interim and permanent loan transaction prior to the commencement of construction. In essence, the lender acts as both the interim construction lender and the permanent mortgage lender. Because of the unique “two-hat” personality of the lender in this type of financing arrangement this type of loan is somewhat rare and is typically provided only by banks or savings banks that have construction lending experience (and also act as mortgage bankers) or mortgage brokers who have wholesale or correspondent relationships with these banks. Other than the fact that the interim and permanent mortgage are closed in a single transaction, this form financing is actually very similar logistically to the traditional construction-to-perm financing arrangement.
The closing costs associated with both arrangements will be almost identical. Under both financing arrangements an origination fee or construction fee (usually ranging from ½ point to 1 point) and several inspection fees (paid for at each “draw” request) will be paid in connection with the construction phase of the arrangement. And under both financing arrangements the borrower will typically (but not always) pay for construction financing with a variable-rate of interest that will only accrue on the draw portion of the principal amount of the loan as draws of principal are made on the loan.
“Construction to Perm” vs. “ One Time Close ”: Which is better?
One possible advantage to using the “ one time close ” arrangement (now formally called a “single-closing” transaction by Fannie Mae) for construction financing is that the qualification process is only required prior to the construction phase. With the traditional “construction to perm” form of financing the borrower, builder and interim lender are at risk that an occurrence beyond the control of the parties could jeopardize the ability of the borrower to “re-qualify” at the completion of the construction phase. Typically, the only event that would create a problem in this regard is where one or both of the borrowers lose their jobs or have a significant decrease in earnings during the construction of the dwelling.
There are limitations to this “advantage”. Per Fannie Mae guidelines (Selling Guide B5-3.1-02) the lender can only utilize credit and appraisal documentation obtained prior to construction when the borrower’s median credit score is less than 700 and the borrower is putting at least 30% of the project cost into the transaction. Per Fannie Mae Selling Guide B5-3.1-02 (verbatim) “If all of the above conditions were not met [at the time of pre-construction approval], the lender must obtain updated credit and/or appraisal documents and re-qualify the borrowers before the mortgage loan is delivered to Fannie Mae.”
Because of the risk of not being able to deliver the closed loan to Fannie Mae on transactions without these lofty credit and cash outlay requirements most “single-closing” lenders will impose these heavy down-payment and credit score requirements on all single-closing transactions. Thus the advantage of only qualifying prior to construction is only viable when the borrower is putting a cash outlay of at least 30% of project cost into the transaction and has a 700 or better median credit score.
There are other disadvantages to the “one time close” procedure. Because the “one time close” program is only offered by a small percentage of wholesale and correspondent loan sources the permanent loan pricing available on these loan programs is typically inferior to those offered by sources that do not offer the “one time close”. Accordingly, the borrower will typically be able to secure a superior permanent mortgage rate with lower costs utilizing the traditional “construction-to-perm” arrangement.
Additionally, the borrower’s qualifications and the underwriting of the application for the “one time close” transaction are conducted as if the transaction were a purchase transaction. This means that “value” of the property for determining the loan-to-value ratio and the maximum loan amount will be the lesser of the appraised value or the project cost (the cost of the lot or land plus the documented cost of construction the dwelling). The fact that the property would appraise for significantly more than what the borrower has into the project would be irrelevant. Unfortunately, most banks and lenders offering a traditional two-close “construction-to-perm” format impose a similar restriction to reduce risk in the construction phase of the process. Simply stated, banks are subject to construction financing limitations that will typically require a minimum cash-outlay equal to 20% of the project cost. A borrower will not be subject to this limitation utilizing AMERIFUND’s Texas 2-Step for new construction which bases maximum loan amount and loan-to-value ratios entirely on the “as-built” appraised value of the property.
In summary, the ability to secure superior rates and pricing on the permanent loan, the flexibility of choosing any suitable loan program and having the option to use appraised value to determine LTV and maximum loan amount for permanent loan pricing with the traditional “construction to perm” method of financing new construction will usually outweigh any other perceived advantage of the “one-time-close”. Borrowers must carefully examine the terms of all the costs on a “one-time-close” and will usually discover that the touted advantages of reduced costs on this type of loan simply are not valid.