PROS and CONS of a One Time Construction Loan

Building your dream home on a specific lot you already own or wish to purchase can be a daunting task, especially when it comes to securing financing.

This is where a “one time close loan” can make a significant difference.

A one time construction loan is a streamlined financing solution that combines the land purchase and construction costs into a single loan with just one closing.

The construction phase is financed with short-term funding, which seamlessly converts into a permanent mortgage upon the project’s completion.

This type of loan can be used for both purchasing a new property and refinancing an existing one.

In this article, we’ll explain the one-time close construction loan, outline the minimum requirements for approval, provide a detailed list of pros and cons, and offer a real-world example to illustrate how it works.

Let’s go!

Summary of Main Points

• One Time Close Construction Loan Overview: A one-time close construction loan combines land purchase and construction costs into a single loan with one closing, simplifying the financing process. This type of loan provides short-term funding for the construction phase, which then converts seamlessly into a permanent mortgage upon completion of the project.

• Eligibility and Benefits: The loan can be used for purchasing a new property or refinancing an existing one, with specific requirements for approval, including credit score, down payment, and detailed construction plans. A construction loan is normally structured as a conventional loan or a VA loan.

• Pros and Cons Explained: One-time close construction loans offer financial flexibility with interest-only payments during the construction phase and can lock in interest rates early, protecting borrowers from future rate increases. However, these loans typically have stricter qualification requirements, including higher credit scores and detailed documentation, which can be challenging for some borrowers. Additionally, they may come with higher interest rates and upfront costs, and the rigid draw schedules and inspection requirements can add complexity to the construction process.

• Need Help? District Lending is an online mortgage broker who can help you secure a one-time close construction loan fast and without the hassle. You’ve got questions. We’ve got expert answers! Get in touch with us HERE. You can ask us anything. Zero obligation. All inquiries are answered within 2 business hours.

What is a One Time Close Construction Loan?

A one time construction loan, also known as a construction-to-permanent loan or a single close construction loan, combines the financing for the construction of a home and the permanent mortgage into a single loan.

This means you only have to go through the loan application and closing process once, saving time and money.

During the construction phase, the loan acts as a line of credit, allowing you to draw funds as needed to cover the construction costs.

Once the construction is complete, the loan converts into a permanent mortgage, typically with a 15- or 30-year term.

What are the Basic Eligibility Requirements?

Obtaining this type of loan involves meeting specific requirements and qualifications.

Here are the typical requirements for a one time construction loan:

Credit Score and Financial Stability

• Credit Score: Lenders generally require a higher credit score for one time construction loans compared to standard mortgages. A minimum credit score of 620 is typically required, though some lenders may require an even higher score.
• Financial Stability: Borrowers must demonstrate stable income and financial stability. This includes a low debt-to-income (DTI) ratio, typically below 45%.

Down Payment and Equity

• Down Payment: A larger down payment is often required, usually ranging from 10% to 20% of the total loan amount. Some lenders may require as much as 25% down.
• Equity: For borrowers who own the land where the home will be built, the land’s value can sometimes be used as equity towards the down payment.

Detailed Construction Plans and Costs

• Construction Plans: Borrowers must provide comprehensive construction plans, including detailed blueprints and specifications of the home to be built.
• Cost Estimates: Detailed cost estimates and a complete budget for the construction project are required. This includes all construction-related expenses, such as materials, labor, permits, and contingencies.

Builder Approval

• Licensed Builder: Lenders require that the builder be a licensed, insured, and experienced professional. They must provide credentials, proof of insurance, and references.
• Builder Contract: A signed contract with the builder is typically required, detailing the construction timeline, cost breakdown, and payment schedule.

Construction Timeline

• Project Timeline: Lenders will require a realistic and detailed timeline for the construction project. This timeline should outline each phase of construction and the expected completion dates.
• Completion Date: The loan will have a specified completion date, often within 12 to 18 months, by which the construction must be completed.

Appraisal and Inspection

• Appraisal: An initial appraisal is required to estimate the future value of the home based on the construction plans. This helps determine the loan amount.
• Inspections: Periodic inspections are required during the construction process to ensure that the work is progressing according to plan and that milestones are being met before funds are disbursed.

Contingency Reserve

• Reserve Fund: Lenders often require a contingency reserve, typically 5% to 10% of the construction cost, to cover unexpected expenses or cost overruns during the construction process.

Permanent Mortgage Qualification

• Qualification for Permanent Loan: Borrowers must meet the lender’s requirements for the permanent mortgage that will replace the construction loan once the home is completed. This involves standard mortgage qualification criteria such as income verification, credit check, and employment history.

Documentation and Paperwork

• Comprehensive Documentation: Detailed documentation is required throughout the process, including personal financial statements, tax returns, bank statements, construction contracts, and builder information.
• Clear Communication: Effective communication with the lender, builder, and any other involved parties is crucial to ensure that all requirements and deadlines are met.

How Does a One Time Close Construction Loan Work?

There’s generally a 3-phased approach to securing a one time close loan:

#1. Application and Approval: You apply for the loan and go through the approval process. The lender evaluates your creditworthiness, income, and the construction plans.

#2. Construction Phase: During this phase, the loan acts like a line of credit. You draw funds in stages, known as “draws,” to pay for construction expenses. Interest is typically charged only on the funds drawn.

#3. Conversion to Permanent Mortgage: Once the construction is complete, the loan converts into a permanent mortgage with a fixed or adjustable interest rate. You start making regular mortgage payments based on the terms of the permanent loan.

PROS of a One Time Close Construction Loan

Here are the detailed pros of opting for a one time close construction loan:

1. Simplified Process

Single Application and Closing

• Efficiency: With a one time close construction loan, borrowers only need to go through the application and closing process once. This not only simplifies the overall process but also saves time and reduces stress associated with multiple loan applications.
• Less Paperwork: Since there is only one closing, the paperwork is significantly reduced compared to applying for separate construction and permanent loans. This makes it easier for borrowers to manage and keep track of their loan documents.

Seamless Transition

• Automatic Conversion: Once the construction is completed, the loan automatically converts to a permanent mortgage. Borrowers do not need to requalify for the loan or undergo another approval process, ensuring a smooth transition from construction to permanent financing.

2. Cost Savings

Lower Closing Costs

• Single Set of Fees: Since there is only one closing, borrowers save on closing costs that would otherwise be incurred twice with separate loans. These costs can include lender fees, attorney fees, appraisal fees, and other closing expenses.
• Reduced Interest: During the construction phase, interest is typically charged only on the funds drawn, which can result in lower interest payments compared to a traditional construction loan where interest might be charged on the entire loan amount from the start.

Locked-In Rates

• Interest Rate Protection: Borrowers can lock in their interest rate for the permanent mortgage at the beginning of the loan process. This protects them from potential interest rate increases during the construction period, providing peace of mind and financial stability.

3. Financial Flexibility

Interest-Only Payments During Construction

• Cash Flow Management: During the construction phase, borrowers usually make interest-only payments on the funds that have been drawn. This can help manage cash flow more effectively, as the payments are typically lower compared to full principal and interest payments.
• Reduced Financial Strain: By paying only the interest on the drawn funds, borrowers can focus their financial resources on other aspects of the construction project, reducing the overall financial strain during the building period.

4. Convenience and Predictability

Streamlined Communication

• Single Point of Contact: Borrowers have a single point of contact with their lender throughout the entire process, from the initial application to the final mortgage conversion. This ensures consistent communication and reduces the potential for misunderstandings or delays.
• Predictable Terms: With a one time close construction loan, the terms of the loan are set at the beginning, providing borrowers with predictable monthly payments and clear financial expectations once the construction is complete.

Reduced Risk of Delays

• Guaranteed Financing: Since the construction and permanent financing are combined into one loan, borrowers are assured that the funding for the entire project is secured. This reduces the risk of financing-related delays that could disrupt the construction timeline.

5. Potential for Lower Interest Rates

Competitive Rates

• Attractive Rates: Some lenders offer competitive interest rates for one time close construction loans, potentially lower than the rates for separate construction and permanent loans. This can result in long-term savings for borrowers over the life of the loan.

Market Conditions

• Favorable Market Conditions: Locking in a low interest rate at the start of the loan can be particularly advantageous in a rising interest rate environment, helping borrowers secure favorable loan terms before rates increase.

CONS of a One Time Construction Loan

Here are the detailed cons of opting for a one time close construction loan:

1. Stricter Qualification Requirements

Higher Credit Standards

• Credit Score: Lenders often require a higher credit score for one time close construction loans compared to traditional mortgages. This is due to the increased risk associated with construction projects.
• Financial Stability: Borrowers must demonstrate strong financial stability, including a stable income and low debt-to-income ratio, to qualify for this type of loan.

Detailed Documentation

• Extensive Paperwork: The application process can be more demanding, requiring detailed documentation of financial history, construction plans, contractor agreements, and project timelines.
• Builder Approval: Lenders typically have stringent requirements for approving builders, which can limit your choice of contractors and complicate the process.

2. Higher Interest Rates and Costs

Interest Rate Considerations

• Potential for Higher Rates: The interest rates for one time close construction loans can be higher than those for traditional mortgages. This compensates lenders for the additional risks and uncertainties involved in construction financing.
• Rate Fluctuations: Although borrowers can lock in a rate at the start, the initial interest rate during the construction phase might be higher, potentially increasing overall costs.

Construction Contingency

• Contingency Fees: Lenders often require a construction contingency reserve, typically 5-10% of the total project cost, to cover unexpected expenses. This adds to the upfront cost of the loan.
• Cost Overruns: If the project exceeds the budget, borrowers may need to secure additional funding, which can be costly and difficult to obtain.

3. Complexity and Rigidity

Draw Schedule and Inspections

• Rigid Draw Schedule: The disbursement of funds is tied to a predetermined draw schedule based on project milestones. Delays or deviations from the plan can disrupt cash flow and slow down the construction process.
• Frequent Inspections: Lenders require regular inspections to verify progress before releasing funds. This can lead to delays if inspections are not completed on time or if issues are identified that need to be addressed.

Limited Flexibility

• Inflexible Terms: Once the loan terms are set, there is limited flexibility to make changes. Any significant alterations to the construction plan or budget may require re-approval from the lender, which can be time-consuming and complicated.
• Builder Constraints: Borrowers are often limited to using builders approved by the lender, which can restrict choices and potentially increase costs.

4. Potential for Financial Strain

Larger Down Payments

• Down Payment Requirements: One time close construction loans typically require larger down payments compared to traditional mortgages. This can be a financial strain for borrowers, especially when coupled with other upfront costs.
• Equity Risks: Investing a large sum upfront increases the financial risk if the project faces delays or issues. Borrowers may find themselves financially overextended during the construction period.

Payment Management

• Dual Payments: Borrowers may need to manage both construction loan interest payments and living expenses simultaneously. This can be challenging, especially if there are unexpected expenses or delays.
• Cash Flow Challenges: Interest-only payments during construction can help manage cash flow, but any mismanagement or budget overruns can lead to financial difficulties.

Example Scenario

Let’s consider a practical example to illustrate how a one time construction loan works:

Scenario: Building a $500,000 Home

• Loan Amount: $400,000 (80% loan-to-value ratio)
• Construction Period: 12 months
• Permanent Mortgage Term: 30 years
• Interest Rate: 4% (fixed rate locked in at the beginning)

Construction Phase

• Draw Schedule: The loan is disbursed in five draws of $80,000 each, as construction milestones are reached.
• Interest Payments: Interest is charged only on the amount drawn. If the average amount drawn over the construction period is $200,000, monthly interest payments would be approximately $667 ($200,000 * 4% / 12).

Conversion to Permanent Mortgage

• Loan Conversion: After 12 months, the loan converts to a 30-year fixed-rate mortgage.
• Monthly Payments: Based on the $400,000 loan amount at 4% interest, the monthly principal and interest payment would be approximately $1,910.

Conclusion & Wrap-Up

A one time construction loan can be an excellent option for financing the construction of a new home due to its streamlined process and potential cost savings.

However, it’s important to consider the higher qualification standards and potential interest rate risks.

By understanding the pros and cons and evaluating your financial situation, you can determine if a one time construction loan is the right choice for your home-building project.

When applying for a one time construction loan, ensure you have detailed construction plans, a realistic budget, and a reputable builder to improve your chances of approval and successful project completion.

Looking For a One Time Close Construction Loan?

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If you’re thinking about a one-time construction loan, or if you have questions about getting the best interest rate, obtaining jumbo loan financing, or any other questions about what loan products you may qualify for, you can get in touch with us HERE.

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About the Author

Brian Reese is a senior advisor and co-owner at District Lending. He is one of the world’s leading experts in veteran benefits, having helped millions of veterans secure their financial future since 2013. Brian is the founder VA Claims Insider, an education-based Coaching & Consulting company whose mission is to educate and empower veterans to get the VA disability benefits they’ve earned for their honorable service. A former active-duty air force officer, Brian deployed to Afghanistan in support of Operation Enduring Freedom. He is a distinguished graduate of management of the United States Air Force Academy and earned his MBA as a National Honor Scholar from the Spears School of Business at Oklahoma State University.

In Brian’s Own Words:

“As a military veteran, I’ve made it my life’s mission to help people live happier and wealthier lives. District Lending brings this mission to life. We believe in integrity, honesty, and transparency, which is why you’ll see our rates right on our website. You’ll find lower rates and zero lending fees, which means you can buy your dream home for less. The savings are passed on to you — the way it should be.”

– Brian Reese, Advisor and Co-Owner, District Lending