Understanding Permanent Loans
Permanent loans are not permanent, but they might feel like they are. The loan maturity is typically between 15 to 30 years. There may be an interest-only payment for part of the loan term. Typically, a permanent loan comes with penalties for prepaying the loan before it matures.
In the construction industry, a permanent loan is given to repay the short-term construction loan the developer took out to complete the project. Businesses may utilize permanent loans to purchase or manufacture fixed assets such as machinery for factories. Permanent loans are also sometimes referred to as permanent financing or long-term equity debt.
What Are Permanent Loans For?
A permanent loan is utilized most frequently by the commercial real estate industry.
- The permanent loan represents the first mortgage awarded to the developer upon completion of the property.
- To move forward with construction, the developer needs to take out a construction loan. The construction loan then converts to a permanent loan, known as construction-to-permanent loan at the conclusion of the project.
Permanent loans are not restricted to commercial developers. Consumers interested in building their own homes also take out permanent loans.
- Until they have a finished home, consumers cannot qualify for a mortgage. However, they may need money now to cover the costs of purchasing land and building their home.
- They take out a construction loan. Upon completion of the property, consumers are eligible for a mortgage. The construction loan becomes a permanent mortgage loan.
In both scenarios, there is no need for a second closing, eliminating a second set of closing costs.
What Does A Permanent Loan Do?
A permanent loan serves as insurance against a changing economy which might depress the mortgage lending industry, making it difficult to finance a home or commercial property.
- The loan begins as a construction loan and then once the project is completed and inspected, it converts to a permanent loan. No external factors come into play.
- There is always risk in the construction industry, especially commercial projects. Lenders are more cautious about construction-to-permanent loans, therefore you can expect a higher interest rate. Also, you will be required to put up a significant down payment, typically 20%.
- While you are in the construction loan phase, your loan’s interest rate is variable, so it can increase or decrease depending on the rate set by the Federal Reserve.
- Once the project is complete, the lender will change the construction loan into a permanent 15 or 30-year loan with an adjustable or fixed rate.
- With a permanent loan, you only need to make one application. You have only one approval process to pass through. You save money in upfront financing costs.
- When building your own home, the construction loan funds go directly to your builder or general contractor.
- If you are building low-income, multi-family properties, you can obtain a construction loan from HUD which will roll it into a permanent loan automatically upon completion.
The construction loan covers the phase of construction through to when you have leased the property. At this point, your financing shifts to a permanent loan.
Permanent Loans In Action
Here is how a permanent loan would work if you are ready to build your own home.
- Find a builder and architect to turn your dreams into reality.
- Complete your construction plans, specs and finalize the details of your contract with the builder.
- Apply for a construction loan.
- Funds from your construction loan are released as your builder completes different phases of the project.
- Once the construction is complete, your construction loan transitions to a permanent loan, or long-term mortgage.
If you are in the construction industry, you know the challenges of obtaining financing.
- Initially, you will secure a short-term commercial construction loan from a bank, usually secured by a first mortgage or deed of trust. Funds can be used to pay for contractors, building materials, equipment, and supplies.
- The lender releases funds in a series of payments, known as draws. These phases are usually determined in advance, and in coordination with your construction schedule.
- Between draws, the bank will send an agent to inspect the progress being made on your project.
- You pay interest only on the outstanding balance.
- After the project is completed, the construction loan is converted into a permanent mortgage. You have the option of choosing an adjustable-rate loan or fixed-rate loan.
Finding traditional financing for new construction without collateral is challenging. Construction companies especially benefit from permanent loans, also known as construction-to-permanent or permanent financing. A permanent loan serves as a hedge against fluctuations in the market and simplifies the financing process.
A single application saves you time and money. The loan funds are distributed on a schedule, according to construction progress. Upon completion, the loan automatically converts to a permanent loan.