Single-Close or Multiple Construction Loans?

Colleagues discussing project on a tablet computer
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Building your own home (or garage, workshop, or other structure) is great because you get exactly what you want. You get to make all of the decisions about design, quality, budget, and more. One of the many decisions you’ll need to make is how to unwind the construction loan after building is complete: will you use a single-closing loan or two separate loans?

Your Options

Construction loans, as the name suggests, are really only for buying land and building (or improving) structures.

They typically last for no more than 12 months, so you need a way to transition to a longer term loan (especially if you want the lower payments that would come with a 30-year mortgage). Once construction is finished, you’ll need to pay off the construction loan – and most people do this by replacing it with a loan that looks more like a standard 15 year or 30-year mortgage.

Single-close construction loans allow you to get both loans (the construction loan and the permanent loan) at once. When construction is completed, your loan becomes a traditional mortgage (your lender might say it gets converted, modified, or refinanced). These loans are also referred to as construction-to-permanent loans.

Two-close construction loans require that you get approved for two loans. The construction loan will fund your project, and then you’ll need to apply for (and get approved for) a permanent loan separately – after construction is completed.

You’ll naturally want to know which is better, and of course it depends on your situation. Some of the pros and cons of conversion loans are listed below.

Advantages of a One-Time Closing

If you like one-stop shopping, you might lean towards a single-close loan.

One application: Applying for a loan can feel like a never-ending research project.

With a single-close loan, you only have to go through the process once.

One closing: Multiple closings mean higher costs. However, the cost difference might not be dramatic (you’ll need to pay several costs – like an appraisal fee after construction is completed – whether you use one or two loans), and you don’t necessarily come out ahead with a single closing.

No payments: ​With some lenders, interest costs during the construction phase can be added to your permanent loan. That makes it easier for you to make housing payments while you wait for your new home to be built, but that also means you’ll owe more (and pay more interest) and make higher payments over the life of that new loan. Plus, postponing payments might be a sign that you’re stretching things a bit thin.

Security: ​Having permanent financing in place – before you ever borrow for construction – means you’re taking less risk. If you lose your job during the construction phase, you’ll still get permanent financing. With a two-time closing, you’d have a hard time convincing a lender to approve your loan while you’re in-between jobs – and that might mean losing the home before you even get to live in it. Any number of things can go wrong during construction, and you have less to worry about if you’ve got a commitment from a lender from the get-go.

Locking rates: ​Finalizing your permanent loan helps you plan for the future. You’ll know what your interest rate will be, so you can calculate and budget for monthly payments well in advance. You can also lock in a rate if you think rates will rise significantly during the construction phase (if rates fall instead, some lenders allow you to adjust).

Advantages of Multiple Loans

Of course, there’s no such thing as a free lunch, so here are a few of the drawbacks of single-close construction loans.

Higher rates: Single-close loans probably come with slightly higher rates (on the construction loan as well as the permanent loan), but you never know until you apply for both and compare offers. When you use a single loan, you lower your risk and enjoy the convenience of one closing; those benefits come at a cost.

Flexibility: When you use one loan, you’ll have to choose a prepackaged program (although you might find a lender that offers exactly what you want – some lenders offer your choice of single-closing 15-year, 30-year, and ARM loans). Keeping your permanent loan separate means you get to go out into the marketplace and apply anywhere you want, for any kind of loan.

No Plans to Build

If you don't know if or when you'll build but you want to buy land, a land-only loan may be a better option. However, it's generally easier to borrow when you've got plans to add to the property in the near future. Buying raw land presents the greatest challenges, while finished lots are much easier to get approved for.