When shopping for a loan for a house that hasn't been built, it pays to know all your options. Some loans are more flexible than others.

The Millers are getting a rather inflexible loan. They can't lock more than 90 days before the scheduled completion date. They won't have to pay anything to lock within 60 days of completion; it will cost one-eighth of a point (less than $200) to lock from 61 to 90 days before the scheduled completion. After they lock, they are committed to that rate -- the lender won't allow them to "float down" if rates drop further.

They get some benefits, too. They are getting an FHA-insured loan from Home American, a lender that is affiliated with their home's builder. As an incentive for borrowing from the affiliated lender, the builder will give the Millers $5,000 to spend on a combination of closing costs and upgrades. They don't have to make payments while the house is being built.

Types of construction loans
There are two major types of construction loans. One consists of separate loans for construction and for the mortgage. The borrower applies and pays closing costs for a construction loan and pays only the interest during construction. Then the borrower applies and pays closing costs for a mortgage that pays off the construction loan. The two loans can be from the same or different lenders. This gives the borrower flexibility to shop for the best mortgage while the house is being built, but at the hassle and expense of applying twice, paying closing costs twice, and making loan payments during construction.

People who get two loans -- a short-term one for construction followed by a long-term mortgage -- tend to want custom-built houses, says Jim Fraser, president of IndyMac Bank's home construction lending division. The construction lender acts as a partner, helping to manage the project: poring over project documentation, hiring an inspector to confirm when each stage of construction is complete.

The two-loan approach was the norm until around the late 1980s, when "there was sort of a new kid on the block -- the construction-to-permanent, one-time close loan," Fraser says. "It's a combination of the two loan programs into one set of loan documents and one closing."

The Millers have this second type: a construction-to-permanent loan. With one set of closing costs, instead of two, these loans usually cost less upfront. Lenders market these loans aggressively because they are longer-term and more profitable. Because payments don't have to be made during construction, these loans are a boon to middle-class borrowers who are paying a mortgage or rent on their current residence.

Various lenders offer a wide range of construction-to-permanent loans. The Millers' loan is fairly basic. On the other hand, IndyMac offers multiple options. The borrower can opt for a low rate during the construction period and switch over to the prevailing mortgage rate when the house is completed. Or the borrower can lock the mortgage rate six, nine or 12 months in advance.

IndyMac doesn't charge a fee to lock at the current rate. Instead, the borrower pays nothing upfront but locks at a higher rate than what is quoted today. For example, a borrower who would qualify for a 6 percent loan today could lock at 6.5 percent or 6.75 percent nine months from now.

"That interest rate increase is my way of hedging any interest rate rises," Fraser says. If rates drop significantly while the house is being built, the bank might let the borrower close at a lower rate.

Locking in advance
Another prominent lender, Wells Fargo Home Mortgage, does things differently. The bank offers two loan programs that allow borrowers to lock a rate far in advance while the house is under construction: Builder Best and Market Option Plus.

With Builder Best, the borrower can lock today's rate on a hybrid adjustable rate mortgage for up to a year. A hybrid ARM has an initial rate for a certain period -- usually three, five, seven or 10 years -- and then adjusts annually thereafter.

"It's a perfect tool, especially in these times, with the rates being among their lowest in history," says John Miller, builder sales manager for Wells Fargo in the District of Columbia, Maryland and northern Virginia. "The likelihood that they'll go down is much smaller than the likelihood that they'll go up."

You pay one point for the privilege of locking so far in advance, and that sum is applied to closing costs. The one-point deposit, as Wells Fargo calls it, helps to prevent borrowers from switching lenders.

Borrowers are allowed to float down the rate once within 60 days of closing if rates have dropped in the meantime. Or, instead of floating down within those last 60 days, the borrower can switch to a 15- or 30-year fixed-rate loan at the current rate.

With Wells Fargo's Market Option Plus, you pay a nonrefundable fee to place a cap somewhere above today's rate. The fee amount depends on how tightly you cap today's rate and how far in advance you do it. If rates drop, you can float down once within 30 days of closing.

Other lenders offer similar programs, and here's how one works: Frank Niro expects his house to be completed in three months. If he pays a fee of half a point, his rate can't rise more than half a percentage point above today's rate over the next 90 days. Or he could pay a fee of three-quarters of a point, and his rate can't rise more than three-quarters of a percentage point over the next 120 days.

Niro isn't biting. "I don't think that rates will increase by more than half a point" in the next month-and-a-half, he says. And at that point, he can lock the current rate free.

Each lender handles rate locks differently. "I think the key to any of these programs is you have to work with a consultant that is willing to take time to explore what is important to the customer, so they can guide them to a program that meets their long- and short-term goals," says Miller of Wells Fargo.

Getting the right loan and the right rate lock can ease a lot of anxiety.

-- Posted: July 1, 2003