1X Close Construction Loans – What’s the deal?
1X Close Construction Loans are primarily what you hear about today when you start to discuss construction financing. So what is a 1X Close, and how is it different than a 2X Close? What are the pros and cons?
The 2X Close: Traditionally a construction loan has been a stand alone loan that is not the 30 year mortgage with principal and interest payments that we are all familiar with. The 2X Close Construction Loan is just the loan for the construction. When the home is done, and the Certificate of Occupancy (C of O) is received, the owner must get a refinance loan to pay off the construction loan. This is the 2nd loan in the process, thus the 2X Close. The refinance would then be the 30 year fixed mortgage (or ARM, or whatever product the owner chooses). The refinance loan doesn’t come in place until the home is done which leaves the owner open to qualification issues that could arise during the construction period.
The 1X Close: A 1X Close Loan is when the construction loan is issued at closing AND the long term 30 year fixed mortgage is also issued at the same closing, prior to even starting the construction. At C of O a simple and automatic modification is recorded and the construction loan balance “terms out” into the 30 year principal and interest payment. No second closing occurs and the entire loan process is done upfront when the construction loan is obtained.
The Benefits: The 1X Close Loan has a number of benefits over the traditional 2X Close. In fact, there are really no downsides and almost no reason to do a 2X Close Loan anymore unless the project is Spec Construction or an Investment Property which may not be allowed under the 1X Close guidelines. Below is a brief explanation of the main benefits:
- Close once = lower costs. Inherently closings require title fees and other closing costs. Closing once limits these expenses to one time and can save thousands of dollars in comparison to closing twice.
- Rate lock – the rate on a 1X Close loan is locked prior to construction of the home and is fixed for the entire construction term, which can be as long as 24 months. The SAME rate is applied to the long term 30 year mortgage. The rate is not “floating” and is not subject to increases in the rate market if rates go up. In a rising rate environment this can be an enormous benefit to the owner as it is essentially a two year rate lock.
- One qualification – the 1X Close goes through underwriting once when the construction loan is applied for. That includes the appraisal (based on the plans and materials list), credit report, and employment verification. There is NO additional underwriting at closing, NO additional appraisal, NO credit report, and NO employment verification done. Think about what can happen over one or two years. An owner could change careers and have diminished income, identity theft can occur and credit scores can plummet, home values could fall meaning a new appraisal would not support the loan. All of these concerns are mitigated with the single upfront underwriting process of a 1X Close.
- Payments during construction – payments during the construction process are interest only payments based on only the amount of the loan used to date. The rate is the same as the long term rate, there is never any increase in rates. The construction loan is like a line of credit. It starts at $0, and as the builder starts to build and draw on those funds the line increases until the home is complete and the entire loan is drawn. Monthly payments naturally increase as the building gets closer to completion, and then the payments will “term out” and become the 30 year fixed mortgage (or whatever product the owner has chosen).
Not all 1X Close Loans are the same: Many companies advertise a 1X Close Construction loan but very few actually deliver on a true 1X Close. Some will require a new appraisal at completion, or pull a new credit report on the owner. Some will even require new underwriting documents on income and employment verification at time of completion. And some companies will require that the rate “floats” during time of construction, meaning the rate is not locked at all and if the rates are higher when the home is done the long term mortgage will be based on a higher rate. Intermountain Mortgage Company offers a true 1X Close Construction Loan. We’ve closed millions of dollars of 1X Close Loans and helped countless clients build homes in the greater Salt Lake City and Park City area. Please reach out to us anytime to discuss a construction project or for lot financing if you are just getting started on the purchase of land. We are happy to consult on construction financing scenarios whether you are building in a few months or not for a few years.
Contact Ian Poor at Intermountain Mortgage