Building your own home, garage, workshop, or other structure is great, because you get exactly what you want. You decide everything, from the design to the quality of finishes, even the budget.
One of the decisions you’ll need to make is what kind of construction loan you should use to pay for your project: a one-time close loan or multiple loans?
- When building or renovating a part of your home, you may wonder which type of construction loan you should use: a one-time close loan, or multiple loans.
- The type of loan that's best for you will depend on your situation, and each type of loan has its pros and cons you'll need to consider.
- Single-close loans can be simpler and more secure with locking rates. Multiple loans may have lower rates and more flexibility.
- If you don't know whether or when you'll build, but you still want to buy land, a land-only loan may be a better option.
Construction loans are intended for buying land and building or improving structures. They typically last only as long as it takes to build the home—about a year or less. Therefore, once construction is done, you'll 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. There are two ways to do that.
One-time 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 may call this getting "converted," "modified," or "refinanced." These loans are also referred to as "all-in-one" or "construction-to-permanent" (CTP) loans.
Two-close construction loans, or multiple loans, require that you get approved for two separate loans. The first loan will fund the physical construction of your home, and then you’ll need to apply for—and get approved for—a separate long-term loan on the completed home, to refinance the construction loan to a 15- or 30-year mortgage.
Which course is better will depend on your situation.
Advantages of Single-Close Loans
If you like one-stop shopping, you might lean toward a one-time or single-close loan, for the following reasons:
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: A one-close construction loan means you pay closing costs once; you'll pay closing costs multiple times if you choose multiple loans.
Deferred payments: Usually, with a construction loan you'll pay interest-only payments over the life of the loan, with a lump sum due at the end. But with some lenders, interest incurred during the construction phase can be added to your permanent loan. (Note that deferring your payments may mean you’ll owe more, pay more interest, and make higher payments over the life of that new loan.)
Security: Having permanent financing in place before you borrow for construction may reduce some risks. For example, if you lose your job during the construction phase, you’ll still have your 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 from the outset 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. And if rates fall instead, some lenders allow you to adjust.
Advantages of Multiple Loans
Applying for two separate loans has possible advantages as well.
Lower rates: Single-close loans may come with slightly higher rates on the construction loan as well as the permanent loan. While single loans may lower your risk and provide the convenience of one closing, those benefits can come at a cost. You may be able to secure lower rates by using multiple loans.
Flexibility: When you use one loan, you’ll have to choose a prepackaged program. Lenders may offer you choices of single-closing 15-year, 30-year, and ARM loans. Keeping your permanent loan separate from your construction loan means you can search and apply for any loan you want—not just the limited offerings available to you from one lender.
No Plans to Build
If you don't know whether or when you'll build, but you still 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. Lenders see land-only purchases as speculative and therefore riskier than if you have plans to build. Therefore buying land presents the greatest challenge to finding financing, while finished lots are much easier to get approved for.