Construction vs. Construction-Permanent
The typical construction loan is normally an interim or short-term financing that provides the borrowers and their contractor with the funds to build a new home. They are short-term loans in that they must be paid off or refinanced immediately after the construction is completed. In some cases, the construction loan will only cover the actual construction of the structure, and not the purchase of the lot on which the structure (house) will be built. Construction loans are riskier for the lender. The lender is lending money for something that does not yet exist, so the requirements for and structure of construction loans are slightly
different compared to those of standard purchase loans of existing (or recently built) structures. The general procedure is for the short-term construction loan to be refinanced with a “permanent” mortgage loan, upon completion. This permanent loan is simply any of the various standard refinance mortgage loan programs available. However, although it is technically a refinance, the permanent mortgage follows standard purchase guidelines. This “permanent” refinance is usually arranged before the construction begins. Failure to refinance a standard short-term construction loan can result in higher interest rates and more
costly payments. Note that if the borrower has paid for the construction with personal funds—but now wishes to be reimbursed for the costs—any new mortgage loan normally would be considered a “cashout” refinance.
To make the financing route easier for construction-home shoppers, many lenders now offer the hybrid Construction-Permanent loans. This program is very similar to the permanent refinancing of construction loans. The difference is that a construction-permanent mortgage loan is an interim construction loan that automatically converts into a permanent mortgage without refinancing.
To determine the maximum Loan-to-Value (LTV) ratio, construction-permanent loans should be considered as purchase mortgages. Whether construction or construction-permanent, most lenders require that all necessary work be completed before the final closing.