Different Kinds of Construction Loans

Financing your new custom home requires a construction loan. Construction loans are generally available in two types: “one-time close” and “two-time close” loans. Let’s explore each type.

One-Time Close Construction Loan

A one-time close loan, also known as a construction-to-permanent loan, is a popular option for borrowers since it streamlines much of the process of financing a home building project. As the name implies, with a one-time close loan, there is only one closing since the initial construction loan automatically converts into a long-term mortgage when construction is complete.

The benefits of one-time close construction loans are:

• One approval process, one closing, and thus one set of closing costs
• Potential to lock in a low-interest rate right from the start
• Potentially pay only interest during construction

These loans can be very useful for someone who has a good idea of how much their project will cost and borrows while interest rates are comparatively low.

Two-Time Close Construction Loan

The two-time close construction loan consists of two parts: the preliminary, short-term construction loan and the actual mortgage. These are actually two discrete loans with unique, separate approval and closing periods, and twice the closing costs of one-time close loans.

While it sounds cumbersome and costly, it can actually be to your advantage given the right conditions. For one thing, you’re not locked into a fixed amount from the beginning. If construction costs go a little higher than the agreed-upon construction loan amount, you won’t have to get extra financing to go alongside the subsequent mortgage.

In addition, since mortgages tend to be lower risk to lenders than construction loans (you have your collateral in place by the time the mortgage starts), you can often get lower interest rates on the second loan.

In summary, the benefits of two-time close construction loans are:

• More competitive rates overall
• Potentially pay only interest during construction
• Opportunity to change to a lower rate once construction is complete