Refinancing a Construction Loan Into a Permanent Mortgage

Construction loans are a practical source of funding when you’re building a new home. However, these loans often have short terms and may come with higher interest rates than other types of mortgages.

Thankfully, refinancing a construction loan into a permanent mortgage isn’t much different from most other types of refis. If you have a construction loan and your property is completed and move-in ready, you can apply to refinance through various conventional and government-backed loan programs.

Highlights

• Homeowners can refinance a construction loan into a permanent mortgage through various conventional or government-backed programs, depending on their loan type and financial situation.
• Construction-only loans require refinancing once the home is complete, while construction-to-permanent loans automatically convert to a mortgage, though refinancing may still be beneficial.
• Refinancing construction loans usually involves meeting standard mortgage criteria, which are often less stringent than those for the initial construction loan.
• Key reasons to refinance include securing a lower interest rate, adjusting the repayment schedule, or paying off alternative financing like a HELOC, though borrowers should weigh the costs.
• Strategies like using a float-down option, considering a streamlined refinance, or shopping around for competitive rates can help borrowers optimize their refinancing outcome.

Understanding the Two Types of Construction Loans

There are two common types of construction loans for residential properties:

• Construction-Only Loans
• Construction-to-Permanent Loans

Construction-only loans are short-term financing that helps cover the costs of purchasing property and building your home. These loans typically have terms ranging from six months to two years and only require you to pay the monthly interest costs until the mortgage matures. 

Once your home is complete, you must repay the construction loan in full. This is usually accomplished by refinancing into a regular mortgage.

Construction-to-permanent loans are a complete financing solution that allows you to buy property and build your home. Once the work is finished, the loan converts into a long-term mortgage. The terms of a construction-to-permanent loan are negotiated before the building begins, although borrowers may have the option to lock in their interest rate upfront or accept the going market rate once the property is move-in ready.

Refinancing a Construction-Only Loan

If you have a construction-only loan, it will need to be refinanced (or otherwise paid off) by the time the note comes due. This is generally within two years of closing and sometimes much sooner. Refinancing is a necessity with this type of construction loan unless you have other ways to pay off the balance in full.

However, the refinancing process should be pretty straightforward once your property is complete. Lender criteria for construction loans are typically higher than for the refinance of a completed property, meaning that if your credit and finances haven’t substantially changed, you should likely qualify for a new mortgage.

Refinancing a Construction-to-Permanent Loan

On the other hand, construction-to-permanent loans do not have the same sense of urgency regarding refinancing. Your mortgage will convert into a permanent loan once construction is complete. Even if you don’t have the best interest rate or terms, you won’t need to worry about your balance coming due if it takes a little while to find the ideal refinance.

Like construction-only loans, refinancing a construction-to-permanent loan with a different lender should be simple once you complete and move into your new home.

Refinancing HELOCs or Other Loans Used for Construction

If you financed your home’s construction with the equity in another property – whether through a cash-out refi, HELOC, or home equity loan – or by tapping into other lines of credit or loans not secured by the subject property, you can still refinance into a permanent mortgage.

The downside is that you’ll almost always need to do a cash-out refinance to satisfy those other debts. Lenders have stricter requirements for cash-out refinances, typically meaning higher credit score minimums and a greater amount of home equity.

Cash-out refinances also have higher interest rates than the standard rate-and-term refi you’d get when converting a genuine construction loan into a permanent mortgage. Costs vary by lender and market conditions, but you could wind up paying 0.5% or more in additional interest costs with the cash-out refi.

What Types of Lenders Refinance Construction Loans?

Most borrowers who refinance their construction loans opt for a conventional mortgage. Conventional lenders offer construction loan refis for up to 95% of the property’s value to homeowners with a 620 credit score. However, as long as your new property is owner-occupied, you have some additional options to consider.

FHA Permanent Mortgages

FHA lenders can refinance your construction loan for up to 97.75% of your home’s value with a credit score of just 580. Since nearly all construction loans require at least 10% down, it may be possible to get an FHA refinance for up to 90% of your property’s appraised value with a score as low as 500.

VA Permanent Mortgages

Homeowners who qualify for a certificate of eligibility from the US Department of Veterans Affairs can apply to refinance their construction loan into a permanent VA mortgage. VA guidelines allow you to refinance for up to 100% of your home’s value. If you owe less on your construction loan than the property is worth, you may be able to take out cash at closing.

Lender requirements can vary, but you’ll typically need a credit score ranging from 580 to 620. Certain mortgage companies may prefer higher.

USDA Permanent Mortgages

The USDA does not allow you to refinance construction loans from other lenders into their program. However, they do offer single-close construction loans that convert into permanent mortgages upon completion. If you’re working with a USDA construction-to-permanent lender, you can get a USDA streamlined refinance once you’ve had your end loan for at least 12 months.

Why Refinance a Construction Loan?

Are you thinking about refinancing your construction loan? In many cases, it could be a smart move. Sometimes, it’s even a necessity. 

Just a few reasons why you might choose to refinance a construction loan include:

• You have a construction-only loan with a brief term
• Other lenders are offering lower rates than your construction-to-permanent end loan
• You would like to shorten or lengthen your repayment schedule
• You want to switch between fixed and adjustable-rate mortgages
• You need to repay alternative financing, such as a HELOC on another property

Disadvantages of Refinancing Your Construction Loan

In most cases, the biggest disadvantage of refinancing your construction loan is paying for closing costs twice. If you built your home with a construction-only loan, you may have no choice but to refinance. Borrowers with construction-to-permanent loans, however, should weigh any potential savings against the added closing costs they’d incur.

Refinancing your construction loan also means requalifying for a mortgage. The good news is that construction financing generally has more stringent requirements than conventional or government-backed end loans. As such, most borrowers who qualify for a construction mortgage and haven’t seen a substantial change in their credit score or financial situation should have little issue with their refinance.

Finally, there’s the overall effort required to put together all of the necessary documents, shop around with multiple lenders, and go through the complete loan underwriting process. While it’s likely worth refinancing to slash your monthly payments, some people may find that a small monthly savings – especially when coupled with additional closing costs – simply isn’t worth the trouble.

5 Tips & Tricks for Refinancing a Construction Loan

If you’re considering refinancing your construction loan, here are five tips and tricks for getting the best deal and smoothest refinance possible.

1. Float Down – Thinking about refinancing your construction loan because you’re locked into a permanent rate that’s higher than what other companies are offering? You may be able to drop your rate with your current lender without refinancing. 

Some providers offer a “float-down option” that allows borrowers to reduce their interest rate before converting into a permanent mortgage.

2. Streamline Refinance – Do you have a government-backed construction-to-permanent loan? If so, you may want to hold off on your refinance. The FHA, VA, and USDA all offer streamline refinance options once you’ve had your end loan for around seven (FHA & VA) or twelve (USDA) months. 

These low-doc refis let you lower your interest and adjust the terms of your mortgage without going through a detailed credit check, verifying your income, or completing a home appraisal.

3. No Mortgage Insurance – If you’ll have at least 20% equity in your completed home, you will likely want to consider a conventional refinance over the FHA-backed alternative. All FHA loans come with mandatory mortgage insurance premiums, both upfront at closing and wrapped in with your monthly payments. 

The upfront mortgage insurance premium is equal to 1.75% of your loan balance, and ongoing premiums range from 0.5% to 0.75% annually on 30-year loans.

Conventional mortgages, on the other hand, only require mortgage insurance if you have below 20% equity. If you’re refinancing with more than that, you won’t have to pay for private mortgage insurance.

4. Shop Around – The single best way to get a great deal when refinancing a construction loan is often to just shop around with multiple lenders. Receiving loan estimates from at least three companies ensures you’re being offered a fair rate and reasonable closing costs. 

You can also use competing quotes to get lenders to fight for your business by providing their best possible offer.

5. Finish the Home First – If you’re trying to refinance a construction loan into another construction loan in the middle of work being done, you’ll likely have difficulty finding a lender willing to take on the mortgage. It may be possible to do in some situations, but you’re probably better off waiting until the home is built to refinance in most cases.

Discover Your Options for Refinancing Your Construction Loan

If you have a construction loan coming due or about to convert into a permanent mortgage, you may be able to refinance it into a regular loan with better terms and lower payments. With enough equity in your new home, you might not even have to pay for mortgage insurance, which can save hundreds a month in some scenarios.

To discover your options for refinancing your construction loan, including whether you qualify to cash out any of your existing equity at closing, check out the current refinance rates and apply with an experienced and reputable lender today.