One-time close vs. two-time close construction loans

How does a construction loan work?

A lender can't hand you the full loan amount on day one, because the house doesn't exist yet. So construction financing works in two phases:

1. Construction phase. Money goes to the builder in stages, called draws, as work is finished and inspected. If you're buying the lot as part of the deal, that's usually paid at closing.
2. Permanent phase. Once the home is done, the financing becomes (or is replaced by) a regular long-term mortgage.

The one-time vs. two-time question is just this: do those phases share one closing, or get two?

What is a one-time close construction loan?

With a one-time close (also called single-close or construction-to-permanent loan), you sign one set of loan papers before building starts. Those papers spell out the long-term loan terms. The loan turns into a regular mortgage, called conversion, when the home is finished.

Fannie Mae's Selling Guide (B5-3.1-02) explains how this works for conventional loans:

• Fannie Mae doesn't buy the loan until construction is complete and the loan has converted.
• No single construction period can be longer than 12 months. The total, including extensions, can't be longer than 18 months. Longer builds must be handled as two-closing loans.
• At or before conversion, only these can change: the interest rate, loan amount, loan term and amortization type (adjustable to fixed only). The loan amount can go up only for documented construction cost increases.
• At conversion, income, job and credit documents generally can't be more than four months old. The exception is when the loan meets Fannie's specific rule, which includes getting a DU Approve/Eligible result (an approval from Fannie Mae's automated underwriting system) at the original closing and meeting loan-to-value limits. If the exception doesn't apply, the borrower must qualify again.
• A completion report (Form 1004D) is required when the home is finished. If the appraiser says the value went down, a new appraisal and qualifying again are required.

Government programs have single-close options too. HUD Handbook 4000.1 includes a Construction to Permanent program for FHA, which closes once before building starts. The borrower must hire a licensed general contractor. The lender must get the borrower's written OK before each payment to the builder. VA says its purchase loans can be used to build a new home. Fewer lenders offer FHA and VA construction loans than conventional ones, so availability varies.

What is a two-time close construction loan?

With a two-time close, you first take out a short-term construction loan. When the house is done, you close a separate long-term mortgage that pays off the construction loan. That can be with the same lender or a different one.

For conventional long-term loans, Fannie Mae (B5-3.1-03) treats the second closing as a refinance, either limited cash-out or cash-out. A new note is required. The lender reviews you based on the long-term loan's terms at that time.

The upside is flexibility. You can shop for the long-term loan when the house is done, pick a different loan type, or handle a build that doesn't fit single-close timelines. The downside is that you qualify, and pay closing costs, twice.

One-time vs. two-time close: side by side

Can you lock your rate on a construction loan?

Rate risk is one of the biggest differences. With a two-time close, your long-term rate is whatever the market offers when the house is done. That could be better or worse than today.

With a one-time close, the long-term terms are set up front, so you have more certainty. Fannie Mae allows the rate to change at conversion. Because of that, some lenders offer a float-down or rate change option if rates drop during the build. Whether that's offered, and what it costs, varies by lender and program. Ask for the details in writing before you commit.

What happens while your home is being built?

Draws and inspections

Money is paid out in stages as work is finished. An inspection usually confirms the progress before each payment. Under FHA's program, for example, the lender must get your written OK before each payment to the contractor. Any money left over at the end goes toward your loan balance.

Payments during the build

On many construction loans, you pay interest only on the amount paid out so far. So payments start small and grow as the builder draws more. Some programs handle this differently, for example with an interest reserve (money set aside to cover interest). Your loan papers will spell out exactly what you owe and when.

Builder approval and contingency

Lenders usually review the builder before approving the loan. They often check licensing, insurance, experience and the building contract. Many lenders also add a contingency reserve (extra money in the budget) for cost overruns. Requirements vary, so I like to bring the builder into the conversation early.

Closing in Georgia

In Georgia, a closing attorney conducts the closing, and the attorney's firm handles the title work and the entire closing.

Which construction loan is right for you?

• Lean one-time close if you want one closing, one set of costs, and less risk of something changing before move-in.
• Lean two-time close if your build timeline or project doesn't fit single-close rules, you want to shop for the long-term loan later, or your construction lender doesn't offer the long-term loan.

Either way, don't sign a builder contract until you've talked with a lender about how the financing will work. If you're planning a build in Georgia, Alabama or Florida, let's talk it through. All loans are subject to credit approval, program guidelines and property eligibility.

Common questions about this topic

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