When building a custom home, one of the most important financial decisions you will face is choosing the right construction loan. Construction loans differ from traditional mortgages because they provide financing for building a home rather than purchasing an existing one. Two of the most common types of construction loans are one-time close and two-time close loans. Each has its own benefits and drawbacks, and understanding their differences can help you make an informed decision.
What is a One-Time Close Construction Loan?
A one-time close construction loan, also known as a construction-to-permanent loan, combines the financing for both the construction phase and the permanent mortgage into a single loan. This means you only have to go through the loan application and approval process once.
Benefits of a One-Time Close Construction Loan
- Single Closing Process – You only go through the loan closing process once, which saves time and reduces closing costs.
- Locked-In Interest Rate – Since the construction and permanent financing are combined, you can secure an interest rate before construction begins, protecting you from market fluctuations.
- Simplified Qualification – You only have to qualify for the loan once, which can be advantageous if your financial situation changes during construction.
- Lower Overall Costs – Because there is only one closing, you avoid paying duplicate fees for loan origination, title searches, and closing costs.
- Less Paperwork – A streamlined process means fewer documents to sign and less back-and-forth between you and the lender.
Drawbacks of a One-Time Close Construction Loan
- Less Flexibility – If costs increase during construction, you may have limited options to adjust the loan amount.
- Potentially Higher Interest Rates – Some lenders may charge slightly higher rates for one-time close loans compared to two-time close loans to compensate for the risk of locking in a rate before construction is complete.
- Limited Lender Options – Not all lenders offer one-time close construction loans, so your choices may be restricted.
What is a Two-Time Close Construction Loan?
A two-time close construction loan involves two separate loans: one for the construction phase and another for the permanent mortgage. Once construction is complete, you must apply for a separate mortgage to pay off the initial construction loan.
Benefits of a Two-Time Close Construction Loan
- Flexibility in Loan Terms – If market interest rates drop during construction, you can secure a lower rate for your permanent mortgage.
- Adjustable Loan Amount – If construction costs exceed expectations, you can modify your financing plan when transitioning to the permanent mortgage.
- Potentially Lower Interest Rates – Since the permanent loan is applied for after construction is complete, you may be able to get a better rate than what was available before construction started.
- Wider Availability – More lenders offer two-time close loans, giving you more options to shop for the best terms.
Drawbacks of a Two-Time Close Construction Loan
- Two Closings, Two Sets of Fees – Because you close on two separate loans, you must pay two sets of closing costs, increasing the overall expense.
- Requalification Required – You must qualify for a new loan once construction is complete, which can be challenging if your financial situation changes.
- Risk of Higher Interest Rates – If market rates rise before construction ends, you could end up with a higher mortgage rate than originally anticipated.
Key Differences Between One-Time and Two-Time Close Loans
| Feature | One-Time Close Loan | Two-Time Close Loan |
|---|---|---|
| Number of Closings | 1 | 2 |
| Interest Rate Lock | Locked before construction | Set after construction |
| Flexibility | Less flexible | More flexible |
| Total Closing Costs | Lower (one closing) | Higher (two closings) |
| Lender Availability | Limited | More widely available |
| Requalification | Not required | Required after construction |
Which Loan is Right for You?
Choosing between a one-time close and a two-time close construction loan depends on several factors, including your financial stability, tolerance for risk, and preferences regarding loan flexibility.
Choose a One-Time Close Loan If:
- You want to lock in an interest rate early and avoid market fluctuations.
- You prefer a streamlined process with a single closing.
- You want to avoid the hassle of requalifying for a loan after construction.
- You are comfortable with a potentially less flexible financing structure.
Choose a Two-Time Close Loan If:
- You are confident that interest rates may drop before construction is completed.
- You want the flexibility to adjust the loan amount if construction costs change.
- You have strong financial stability and are not worried about requalifying for a second loan.
- You prefer more lender options to choose from.
Additional Considerations When Choosing a Construction Loan
- Loan Limits and Down Payment Requirements – Some lenders require higher down payments for construction loans. Ensure you meet the financial qualifications.
- Lender Experience – Work with a lender experienced in construction financing to ensure a smooth process.
- Construction Timeline – Consider the estimated time for construction and how it aligns with the loan terms.
- Builder Experience – The experience and reputation of your builder can impact loan approval and project completion.
- Market Conditions – Pay attention to interest rate trends and how they may affect your final mortgage.
Conclusion
Both one-time and two-time close construction loans offer unique advantages and disadvantages. If you value convenience, lower closing costs, and a predictable interest rate, a one-time close loan may be your best option. However, if you prefer flexibility, the potential for lower rates after construction, and the ability to adjust your loan amount, a two-time close loan may be the better choice.
Before making a decision, consult with a lender who specializes in construction financing and carefully assess your financial situation. By understanding the differences between these loan types, you can select the option that best meets your needs and ensures a smooth home-building experience.