A general "single close construction loan" is a product which combines a traditional bank construction loan, to finance the construction of your new home, with a long-term mortgage loan of your choice (fixed, adjustable, etc.). It is a useful tool for anyone wanting to build their own home.
After discussing with your lender the amount of mortgage, payments, and the building costs, a mortgage loan is processed in the amount needed to build the home minus your down payment or funds already applied toward the lot. The loan information provided is used for both the construction loan and the mortgage loan. Next, your plans and specifications (list of items to be included in the home) worked out with your builder are brought into the bank so that an appraisal can be ordered based on those plans. This appraisal will provide an estimated value of the home as if it was already finished. Usually, the maximum construction loan amount is 80% of the total cost to build, including land costs and architectural fees.
Portions of the construction loan (called "draws") are disbursed monthly to the builder. Once the construction loan is approved, and you and the builder are ready to start construction, a closing at the title company is scheduled. The first draw on your construction funds is used to pay off any existing land loan. Each month, draws are made from your construction loan based on the work completed by the builder. This request is made by the builder, and the bank then sends a building inspector to ensure that the work has been completed. The funds requested for completed building work is then disbursed from the construction loan, which works similar to a line of credit. Each month, the owner receives an interest bill on the funds that have been disbursed. Therefore, the monthly payment grows as more work is completed on the home and more funds are drawn. Eventually, all of the funds are drawn as the home is completed and the debt is then converted to a mortgage.
A "single close construction loan" is generally for a term of 12 months and then converted to a fixed or adjustable rate mortgage. The benefit of a single close loan (combining construction and mortgage) is a reduction in your closing costs (because you're only closing once) and the establishment of a banking/lender relationship with one institution instead of two. It is important to choose a reputable and experienced bank lender who you feel comfortable with, and with competitive programs, and rates, just as you would shop around for a builder. Evaluating all of your options is a critical part of the process, and will help ensure that the building of your new home is a great and memorable experience.