Solving Inventory Challenges with Construction Loans

In a past post, we discussed renovation loans and identified similarities with the better-known construction-to-perm (or construction loans for short). In this post, we’ll expand upon those differences and give you a more thorough understanding of construction-to-perm loans.

There are some significant differences between the two programs that we will explore. But let’s focus on the opportunity that exists for lenders today in marketing construction loans.

What Are Construction Loans?

Commonly referred to as C-to-P loans, construction loans are perfect for the borrower who is starting from scratch on a new-build property and/or taking on a much larger scale renovation.

The borrower obtains a loan that funds the construction as well as the long-term financing. Construction loans are typically used for custom build projects or in communities or subdivisions not controlled by a large-scale developer. Larger developers and production builders frequently contract to sell the home, but the financing by the buyer is not closed until the build is complete.

Construction loans can vary in structure, and the monthly payments required differ significantly from those of renovation loans.

Below are two breakdowns of typical C-to-P loan structures.

C-to-P Version #1: Two-Time Close Process

  • Structure: Short-term construction loan (typically 9-12 months) is refinanced into a long term, permanent mortgage loan post-construction
  • Interest Payments: Borrower typically pays interest-only payments on the construction loan
  • Principal Balance: Increases over the course of the construction period as disbursements are made to the builder
  • Upon Construction Completion: Permanent financing with fully amortizing principal and interest payments begins

C-to-P Version #2: One-Time Close Process

  • Structure: A single loan transaction that funds construction and then is modified/converted into a long-term fixed-rate loan
  • Interest Payments: Borrower typically pays interest-only payments during construction period
  • Principal Balance: Increases over the course of the construction period as disbursements are made to the builder
  • Upon Construction Completion: Loan is modified to fully-amortizing payments

In both scenarios, like the renovation product, the lender is responsible for managing the disbursement requests from the builder. Disbursement funds are drawn off the loan, increasing the principal balance owed with each advance until fully disbursed.

Unlike renovation loans, there is no limitation to what percentage of the loan proceeds may be used directly for the construction improvements. Loan-to-value limits are established by the lender and typically measured against either the as-completed value (if borrower already owns property or has held title to property for greater than one year) or lot/property acquisition cost plus construction costs.

So while the concept is similar, there are significant structural differences in the loan products. As a summary, let’s take a side-by-side look at the variances between the two types of loans:

Renovation Construction to Perm
Loan funding Fully funded at loan closing Funds as construction draws are made
Loan payments Full amortizing payments from time of loan closing Interest-only payments on drawn principal until fully disbursed and converted to permanent financing
Construction funds Held in an interest-bearing account during construction Drawn from loan as disbursed; adds to principal balance of loan
Sale to Fannie Mae Loan may be sold to Fannie Mae at origination, but servicing must be retained until post-construction Loan cannot be sold to Fannie Mae or servicing transferred until construction is complete and in permanent financing
Timing of MI activation At time of loan closing 1) At time of loan closing/prior to completion or;
2) After completion of construction
Length of MI commitment 120 days 12 months

Both products present attractive product expansion opportunities for lenders and provide borrowers with additional options as we face the inventory challenges of today.

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