Why Consumers are Better Off with Single-Close Construction to Permanent Loans
Consumers wishing to build a custom home have some interesting options in obtaining interim construction financing along with their permanent, or “take-out” financing.
Traditionally, consumers obtain interim construction financing from a bank or credit union to fund the construction of their new home. Once the home is completed, the consumer then pays the construction loan off with a second loan that is their permanent 30 year financing (take-out), usually from a mortgage company. This process is referred to as a “Two-Time Close.”
This approach has worked well for many years but as in all things – “The times, they are a changing.” Consumers seeking financing for a custom home build should look closely at the new generation of hybrid construction to permanent loan products before making any decision.
In this article, I will outline six reasons single-close construction to permanent loan are better for consumers. First, I want to give you more background on what these hybrid construction loans are and how they work.
WHAT IS A SINGLE-CLOSE CONSTRUCTION TO PERMANENT LOAN?
A Single-Close Construction to Permanent (SC CTP) loan is a home mortgage that can be used by the borrower to close both the construction loan and permanent financing of a new home at the same time. They are sometimes referred to as “construction to perm”, “single close”, “one time close”, “construction conversion,” “CTP”, or even “all in one” loans.
While it is true that portfolio lenders have offered versions of these “CTP” loans over the years, the current availability and popularity of these loans has been made possible largely by the Secondary Mortgage Market and the GSE’s. Fannie Mae, Freddie Mac, FHA, VA, USDA all offer a CTP loan in slightly different versions.
For ease, I will refer to these loans collectively as SC CTP throughout this article.
HOW DOES A SINGLE-CLOSE CONSTRUCTION TO PERMANENT LOAN WORK?
The one thing that all these SC CTP variations have in common, is that a SC CTP offers both the interim construction loan and the permanent 30 year loan under one Promissory Note and One Deed of Trust with a single loan closing.
The borrower will sign the 30-year amortizing promissory note at the closing and at the same time sign a modification agreement to that note. This agreement modifies the note from an amortizing to an interest-only note, with interest due only on that amount that the Lender has actually disbursed in accordance with a Construction Loan Agreement, based on the stage of construction.
6 PRIMARY REASONS YOU NEED TO CONSIDER SINGLE-CLOSE CTP LOANS
Why is this important for you? Let me discuss the six primary reasons SC CTP loans are the best for borrowers:
1. YOUR BORROWER ONLY NEEDS TO QUALIFY ONCE
Gathering up all of qualification documents such as, pay stubs, W2’s, tax returns, bank statements, photo IDs, and signing loan disclosures is both time consuming, confusing, and inefficient for your borrowers.
A traditional two-time close loan requires that a borrower qualify not two times, but oddly enough three times – Once for the construction loan; once for the permanent “take-out” loan to prove that they can pay off the construction loan; and then, again a year later when the house is actually complete because now the original documents and approval have all expired!
A SC CTP loan only requires the borrower to go through this process one time and one time only!
2. ONE-TIME QUALIFICATION PROCESS REDUCES RISK FOR BORROWERS
Not only is one-time qualification process a matter of convenience to the borrower, it serves as a risk management tool for the borrower.
There is an element of risk to the borrower in a two-time close transaction because they still have to re-qualify for the “take-out” loan when the house is finished. If this qualification fails to materialize for any reason, the borrower would be unable to pay off the construction loan at maturity and could be forced into a loan workout or even lose the house in a foreclosure action. This element of risk is eliminated by a SC CTP loan.
3. FIXED INTEREST RATES
With a SC CTP loan the interest rate during construction is pre-determined AND the interest rate of the permanent loan that the construction loan will convert to is also pre-determined when the borrower closes the loan. There are no surprises. Not so with a Two-Time Close.
The interest rate of a Two-Time Close during construction is usually an adjustable rate and the interest rate for the permanent “take-out” loan will not be set until the house is completed – usually a year later. A lot can happen to interest rates in a year and the consumer can be at risk of not being able to qualify for a higher rate.
4. REDUCED CLOSING COSTS
Mortgage loan closing costs can be a significant expense to the borrower, usually 3% to 4 % of the loan amount. Closing one loan instead of two loans can save the borrower thousands of dollars. This savings can then be better spent on things like landscaping, furnishings, window coverings, utility deposits, etc., usually not included in the cost of construction.
5. SINGLE APPRAISAL VALUATION ELIMINATES SURPRISES
Two-Time Close loans are usually going to require two separate appraisals, by separate appraisers, both paid for by the borrower. The first is done for the construction loan and the second done for the “take-out” loan when the house has been completed, usually around a year later.
The maximum loan amount is determined by calculating the loan to value ratio (i.e., divide the loan amount by the value and you will get the loan to value.) If the second appraisal comes in at a value less than the original, then the borrower will have to make up the difference in cash – a big surprise!
A SC CTP loan usually only requires one appraisal prior to closing the SC CTP loan. This means no surprises when the house is completed.
6. INTERVENING LIENS DO NOT EXIST IN SC CTP LENDING
This is an issue that no one really likes to talk about. An intervening lien is what occurs when a borrower obtains a two-time close transaction that does not convert to a permanent and requires the closing of a second loan; and, therefore the recordation of a second Deed of Trust to payoff the construction loan.
For example, if the borrower or builder has a dispute with the quality of work of a sub-contractor and therefore withholds the subcontractor payment hoping to get resolution, and that does not happen, and the subcontractor files a “mechanics lien”, this is referred to as an intervening lien.
The intervening lien effectively prevents the borrower from closing on the permanent loan that will pay off the construction loan. The new permanent loan to be recorded into a first lien position both the construction loan, (in 1st lien) and the mechanics lien, (a 2nd lien) have to be paid off. This can become a critical issue for the borrower if the construction loan is maturing and the borrower has locked the rate on the new permanent loan and only has days or weeks to fund the loan. While it is true the sub-contractor still has to prove in court that this is a valid mechanics lien (usually within 60 days) it is still a powerful tool for the sub-contractor to use to get paid.
Intervening liens do not exist in SC CTP lending. Any mechanics lien filed is simply filed in a 2nd lien position behind the SC CTP loan, which has a 30 year term and does not require a second closing; and, therefore the recordation of a 2nd Deed of Trust.
The driving force behind the growth of Single Close Construction to Perm loans over the past few years has been the Secondary Mortgage market and the severe lack of housing inventory. The involvement of the secondary mortgage market in what was once considered to be niche loan product is quickly evolving into a mainstream loan product that lenders of all types and sizes will be offering the consumer in the future.
Look for many exciting announcements from the GSE’s on this in the future and get ready to offer this exciting and consumer-friendly product.