Although some builders are finding it easier to come up with financing needed to erect houses, others have clients take out construction loans instead.
This type of single-close financing is called a construction-to-permanent loan because once the house is finished, the loan automatically switches to permanent financing.
There’s nothing inherently dangerous with construction-to-perm, or C2P, financing. After all, the best custom builders in the country use the tactic to fund their clients. And absent a few extra risks buyers have to consider, these loans are fairly benign. Indeed, they can be beneficial.
One obvious benefit is that you may be able to obtain C2P funding at a lower cost than the builder can, meaning your house can probably be built for less money. And since there is only one closing involved (at the outset of the mortgage), there’s only a single set of expensive settlement fees.
Sometimes known as “single-close,” “one time close” or even “all-in-one” loans, C2P mortgages are all over the ballpark, meaning that there is little standardization. One lender might want to review the builder’s banking references, another may not. One lender might want to document a builder’s licenses and lien release and payment schedules. Another lender might only want to sneak a peek at a builder’s gross sales.
These are things home buyers need to think about, too. We’ll get to them momentarily; first, let’s consider the potential savings:
Because most buyers can obtain a construction loan at about 3 percentage points less than a typical builder, the savings on a $200,000 bonus over a normal 180-day construction cycle is about $3,000. And since that is $3,000 in costs the builder no longer incurs, he or she may be willing to knock that much off the asking price.
There’s also $2,000–$3,000 in savings because there are no longer two sets of closing costs, one when the builder takes out a construction loan and another when the buyer takes out a permanent, or end, mortgage. Because C2P loans are two loans in one, there is only a single closing. Some lenders may charge a higher rate on a C2P loan since the home is not yet complete and thus not as valuable an asset to secure their loan. However, the savings from eliminating one unneeded closing may easily exceed any premium in interest rate.
The construction portion of the all-in-one loan can run anywhere from six to 12 months, giving the builder plenty of time to complete the house. During that period, you pay interest only — and only on that portion of the total that you’ve actually used to that point to build the house. But since the property is in your name, you are responsible for the property taxes on a house in which is not yet complete and you have yet to occupy.
That builders don’t have to put up their own money is a benefit to the builder, too, especially those who don’t have the financial creds to borrow on their own. But that puts the onus on the buyer to: 1) make sure the builder you choose is credible and 2) make sure the builder pays all bills they incur.
Since not all lenders have the necessary checks and balances in place to protect your interests, you should scrutinize your builder’s references and bank accounts to be certain the builder is stable. Remember, you are on the line, not the lender — or the builder — if something should go wrong.
With normal financing, if you should lose your job, suffer a medical catastrophe or just have a change of heart, you can usually back out of the deal and all you will lose is the deposit you gave the builder. But with single-close loans, there’s no changing your mind after construction starts — for any reason.
Over the course of construction, the builder will ask for money from you. These “draws” typically occur at closing to start construction, when the foundation is finished, when the framing is complete and finally when the house is finished. It is up to you to make sure the house is really completed to those points before you sign off on disbursements.
Since not all lenders have the necessary checks and balances in place to protect your interests, you should scrutinize your builder’s references and bank accounts to be certain the builder is stable. Also, since some lenders may not do enough to make sure the builder pays his subcontractors and other bills, it’s a wise idea to collect signed lien release forms from all sub-contractors and suppliers every time the builder asks for money. If you don’t, and, say, the plumber isn’t paid, the plumber can attach a lien on your house and you’ll have to pay that bill if you ever want to resell.
Moreover, make sure the checks the builder writes have been deposited and cleared before making the next payment. It’s only after your money becomes “good funds” in the builder’s account that the right to file a lien is actually extinguished.
Your lender may obtain personal and business credit reports on your builder. And the lender might check him out with his banks, subcontractors, and suppliers to make sure he pays his bills. But once the bank approves the builder, it is sometimes lax in making sure the builder follows sound business practices.
Even if the bank continues to monitor the builder, it may not pay the same attention you would to the quality of the builder’s work. Some lenders require — and make you pay for — third-party inspections before they release funds. But still, you should be the final arbiter of when to disperse money to your builder.
Once the place is finished, the construction loan converts seamlessly into the permanent loan of your choosing, either a fixed-rate mortgage of 15 or 30 years’ duration or an adjustable-rate loan. But you have to decide upfront what kind of loan you want. You can’t wait until the house is done because your choice will affect the rate you pay.
Lew Sichelman is a nationally syndicated housing and real estate columnist. He has covered the real estate beat for more than 50 years.
With single close loans, what is the standard practice for documentation when the loan is converted? In your example that someone loses their job does the lender recheck for sources of income or once approved it’s never looked at again.