A construction to permanent loan, or C2P loan, enables a borrower to finance the cost of building a new home or significant renovations, including for a tear-down or fixer upper, with a single mortgage. A construction to permanent loan is a potentially attractive alternative to a borrower arranging two separate loans to build or renovate a home: one short-term construction loan to finance property renovations and a second, permanent mortgage that replaces the construction loan when the project is completed.
Review How C2P Loans Work
Using a construction to permanent loan enables the borrower to have one mortgage closing instead of two, reduce closing costs, arrange a permanent mortgage long before completing property construction and lock-in the interest rate for the permanent mortgage six months to a year in advance of completing the project. Not all lenders offer construction to permanent loans but many do. The best lenders for construction loans include regional banks, credit unions and banks where you have an existing relationship.
Not all lenders offer construction to permanent loans but many do. The best lenders for construction loans include regional banks, credit unions and banks where you have an existing relationship. Use the FREEandCLEAR Lender Directory to find lenders that offer C2P loans.
The FHA 203(k), HomeStyle Renovation and CHOICERenovation mortgage programs enable home buyers to finance the purchase of a home as well as the cost of significant remodeling and repairs to the home with one mortgage. These programs work well for home buyers looking to purchase a fixer upper because they allow borrowers to finance the cost of fixing up a property without having to obtain a separate construction loan which can be costly, complicated and time-consuming to arrange. The FHA 203(k) Program applies only to owner-occupied properties while the HomeStyle Renovation and CHOICERenovation programs apply to both owner-occupied and single unit investment properties.
With the FHA 203(k) Home Loan Program, the value of the property is determined by either the value of the property before the remodeling or rehabilitation project plus the cost of the project; or, 110% of the appraised value of the property after the remodeling project, whichever is less. The FHA 203(k) Program requires additional up-front and ongoing borrower fees.
With the HomeStyle Renovation Program, the value of the property is the lesser of the purchase price plus the cost of the renovations or the appraised as-completed value of the property. The program charges a higher mortgage rate and closing costs and applies stricter borrower qualification requirements. Additionally, the program does not permit sweat equity.
The CHOICERenovation Program uses the after renovation property value to determine the mortgage amount you are eligible for. Additionally, when combined with certain loan programs, a CHOICERenovation mortgage only requires a down payment of 3% of the property purchase price.
The FHA 203(k) and HomeStyle Renovation programs are offered by approved lenders. Contact the lenders in the table below to understand the fixer upper mortgage programs they offer.
You can also use our lender directory to find lenders that offer the FHA and 203(k) and HomeStyle Renovation programs.
If you decide to not use the construction to permanent (C2P), FHA 203(k), HomeStyle Renovation or CHOICERenovation programs, the first step to getting a mortgage for a fixer-upper is to buy the property based on its current fair market value, before any remodeling or improvements are factored in. Without using one of the fixer-upper mortgage programs outlined above, most banks do not offer borrowers a mortgage that includes the cost of improvements.
For example if you want to buy a fixer-upper that is worth $200,000 and make $50,000 worth of improvements, the bank will most likely only give you a mortgage based on the $200,000 value of the property before improvements. It is important that you only pay for the property based on what is worth today even though it will be worth more after you fix it up, because this is the way the bank thinks about your mortgage.
After you purchase the property at its fair market value you can obtain a construction loan to finance the remodeling and improvements you want to do. A construction loan is typically a six-to-twelve month loan that charges a higher interest rate than your mortgage, but usually only requires you to pay interest, so the monthly payment is lower. Not all banks offer construction loans but many do and the bank that you use for the mortgage on the property may provide construction loans.
A borrower must qualify for both the mortgage to purchase the property as well as the construction loan based on the borrower’s income and debt so it is important to understand what size mortgage and construction loan you qualify for before you start the home purchase process -- the last thing you want to do is buy a fixer upper and then not have the ability to finance the remodeling. You should have the construction loan lined-up and ready to go before you buy the property so that you can begin remodeling immediately after the purchase closes and there are no issues financing the renovations.
Use our Mortgage Qualification Calculator to determine what size loan you can afford based on your gross income and debt
After your remodeling is completed, you get a permanent take-out loan to pay-off the construction loan and refinance the original mortgage used to purchase the property. The lender for the take-out mortgage uses a new appraisal that factors in any home improvements to determine the value of the property. The more valuable the property, the larger the mortgage you qualify for, assuming you can afford the monthly payment. After the permanent mortgage is in place, you will have paid of the construction loan and have a new loan based on the after renovation value of the property.
It is important to highlight the risks to financing a fixer upper through a construction loan and take-out mortgage. First if your financial profile changes significantly during the course of remodeling the property, such a job loss or drop in your credit score, you may not be able to qualify for the permanent mortgage.
Second, there is no guarantee that the renovations result in the increase in property value you expect, which could hinder your ability to qualify for the take-out mortgage. For example the appraisal may show a property value less than the original purchase price of the property plus the cost of the improvements. While this is a worst case scenario it demonstrates the risk of buying a fixer upper with two loans instead of a single mortgage.
It is important to work with potential take-out lenders in advance of buying the fixer-upper to limit potential disagreements about the value of the property after the remodeling. In many cases a construction loan lender will not fund the loan until the borrower has arranged the permanent take-out mortgage.
If a borrower is concerned about obtaining a construction loan and take-out mortgage he or she may want to make a lower down payment and pay for the remodeling out of pocket. For example, instead of making a 20% down payment, the borrower makes a 5% down payment and uses the difference in down payments to pay for all or part of the property improvements. This may also minimize the need for the borrower to obtain a construction loan and take-out mortgage. Reducing your down payment means that you need a larger mortgage to buy the home and you must be able to qualify for the higher loan amount.
Understand the Down Payment Required to Buy a Home
It is important to understand that if you make a down payment of less than 20% lenders typically require that you pay private mortgage insurance (PMI), which is an additional monthly cost on top of your mortgage payment, or the lender may charge you a higher interest rate. In this scenario, the borrower could refinance his or her mortgage after the remodeling is done and assuming the value of the property has increased and the borrower’s equity in the property has grown, the borrower may not be required to pay PMI or the lender would offer a lower mortgage rate.
If you cannot arrange a mortgage for a fixer upper through a traditional lender you may be able to get a mortgage through a hard money lender, also known as a private lender. Borrowers can use a short-term hard money loan, such as a bridge loan, to finance the purchase and renovation of a property and then refinance the hard money loan with a traditional mortgage with a lower interest rate, after the property is remodeled
Hard money loans typically charge an interest rate that is 4.0% - 7.0% higher than a traditional mortgage plus higher lender fees. Additionally, a hard money loan may require a lower loan-to-value (LTV) ratio which means that the borrower must make a higher down payment or equity contribution. Although a hard money loan is much more expensive than a usually traditional mortgage it is another alternative for a buyer seeking to finance a fixer upper.
C2P Mortgages: https://www.fanniemae.com/content/fact_sheet/construction-permanent-matrix.pdf
FHA 203(k) Program: https://www.hud.gov/program_offices/housing/sfh/203k/203k--df
HomeStyle Renovation Program: https://www.fanniemae.com/content/fact_sheet/homestyle-renovation-overview.pdf
CHOICERenovation Program: https://sf.freddiemac.com/working-with-us/origination-underwriting/mortgage-products/choicerenovation