Locking down a construction loan
If one set of consumers feels especially anxious nowadays, it consists
of people whose houses are under construction, but who can't yet
lock a mortgage rate.
They itch to get into their houses, fret over delays
and worry that rates will rise before they can lock.
"It's something we think about all the
time, talk about all the time," says Betsy Rice Miller. She
and her husband Anthony are having a house built outside Phoenix.
The three-bedroom stucco ranch will be the first house they own.
They can lock a mortgage rate up to 90 days before the house's scheduled
completion. That lock-in period begins in about two weeks, and they
are obsessed with rates and what causes them to go up and down.
"A lot of it has been surrounding the
war -- which way it will go," Miller says. Rates have risen
since the war in Iraq began, but she wonders if they will drop after
the war ends and investors focus on the unpromising economic landscape.
"It's frustrating because if we could
lock now, we would," she says. "The rates are pretty much
where we wanted it -- about 6 percent."
A home construction boom has put a lot of people
in a similar situation. Many of these borrowers have contracts with
lenders that don't allow them to lock a rate until 90 or 60 days
before the scheduled completion date. They watched helplessly as
mortgage rates bottomed out last month, and they're crossing their
fingers in hopes that rates won't rise before they can grab a guaranteed
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
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
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
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
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
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 mid-July.
If he closed today, he probably could get a 30-year fixed-rate loan
at 6 percent. He could pay half a point to cap his mortgage rate
at 6.5 percent 90 days from now or pay three-quarters of a point
to cap his rate at 6.75 percent 120 days from now.
Niro isn't biting. "I don't think that rates
will increase by more than half a point by May 15," 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.