Constructions Loans

Extended rate locks for construction loans
- By Holden Lewis • Bankrate.com

Financing
If one set of consumers feels especially anxious during this time of low mortgage rates, it consists of people whose houses are under construction, but who can't yet lock a rate.

They itch to get into their houses, fret over delays and worry that rates will rise before they can lock.

They can lock a mortgage rate up to 90 days before the house's scheduled completion and they are obsessed with rates and what causes them to go up and down while they wait and also because the rates are what they want but can't have .

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 watch helplessly as mortgage rates drop and then drop some more, and they're crossing their fingers in hopes that rates won't rise before they can grab a guaranteed rate.

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.There are points to pay for locking in a rate for different periods before completion, and often "float down" is not an option availaable to borrowers. They may get some advantages for borrowing from their own builder;s affiliated lender like some discounts on closing costs and no payments while the house is being finished.

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 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, It's a combination of the two loan programs into one set of loan documents and one closing 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 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.

Locking in advance
Another program is when the customer opts for the 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.
Sometimes you pay one point for the privelege of locking way in advance and that sum is applied to closing costs, this also prevents 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.

Different lenders ahve different programs as incentives for borrowing and each works a little differently
Each lender handles rate locks differently. 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 you, so they can guide you to a program that meets your long- and short-term goals.Getting the right loan and the right rate lock can ease a lot of anxiety.

How construction loans work

Q. Can you explain how construction loans work?
Construction loans are story loans. That means that the lender has to know the story behind the planned construction before they're willing to loan you money. Because it's a story loan, it's not going to be standardized like mortgage loans underwritten to Freddie Mac or Fannie Mae guidelines. That said, there are some common features to a construction loan. Construction loans typically require interest-only payments during construction and become due upon completion. Completion for homeowners means that the house has its certificate of occupancy.

Construction loans are usually variable-rate loans priced at a spread to the prime rate or some other short-term interest rate. You, the contractor and the lender establish a draw schedule based on stages of construction, and interest is charged on the amount of money disbursed to date.

Another variable in construction loans is how much of the project cost the lender is willing to lend. If you already own the land, then that can be considered as equity on the construction loan.

Many homeowners use construction-to-permanent financing programs where the construction loan is converted to a mortgage loan after the certificate of occupancy is issued. The advantage is that you only have to have one application and one closing.

Depending on your view on interest rate trends, you could also purchase a rate-lock agreement valid through the expected completion of the construction. Just make sure you allow for the inevitable construction delays.

A construction loan, unlike a mortgage, isn't meant to be around for a long time. If you're taking out a $200,000 construction loan for six months and you pay an extra 0.5 percent on the loan, it costs you an additional $250. (Assumes an average $100,000 loan balance over a six-month construction period.)

You may be willing to pay a higher rate on the construction loan if you're doing construction-to-permanent financing and can get better mortgage terms or a longer, better rate lock from that lender.

Financing a major home renovation

Q. If one is planning a major home renovation like an addition to a home, what is recommended, a home equity loan or a construction loan, and why?

Ideally, you would combine the construction loan with your existing mortgage into a new first mortgage. You'd only look at a second mortgage (home equity loan) if the appraisal weren't high enough to justify the new, larger first mortgage.
The real key to successfully financing the addition is in how the addition increases the appraised value of your home. Payback estimator provides both regional and national averages for different remodeling projects.
The higher the loan-to-value, the harder it will be to roll the construction loan into a new first mortgage. That's when you would want to consider a home equity loan vs. refinancing.

Converting a construction loan

Q. What's the best strategy for converting a construction loan?

You should take out a mortgage to pay off the construction loan. Construction loans aren't meant to be a method of long-term financing. A first mortgage is a better choice than a home equity loan because you can borrow for longer periods, generally at a lower interest rate.
A typical home equity loan is a second mortgage. It carries a higher interest rate than a first mortgage because there is more risk to the lender. That's because the first mortgage has to be satisfied before any sale proceeds go toward satisfying the second mortgage. With no other lender having priority in the event of foreclosure, you've given the home equity lender all the benefits of being the primary lender.
You should get better terms on a first mortgage than you would on a home equity loan.

Interest paid on a construction loan

Q. How does one handle construction loan (for construction of a primary residence) for part of the year . is the interest payment deductible?

Anybody brave enough to bear dealing with contractors deserves a tax deduction. To qualify as home mortgage interest, you need to meet the same rules that apply to the general deduction for home mortgage interest.
One of the rules requires that the loan be secured by your primary residence. Since it would be highly difficult to occupy a home under construction, the law gives you a break. You can treat a home under construction as your primary or second home for up to 24 months. This treatment applies if the home becomes your primary or second residence when it is ready for occupancy.
Financing the building of a new home

Q.How do we finance the building of a new home while selling our current home?

You could potentially use four different loans in financing the home: a land loan, a construction loan, a bridge loan and a mortgage loan. If you pay cash for the land, your construction lender has to be willing to finance the building project with $0 to $5,000 down, plus hold the land as collateral. Alternately, you could choose to combine the two loans, land and construction, with $50,000 down. Either way, you end up borrowing $195,000, so choose the least-expensive option.

If you have your plans, land and contractor all lined up, you can bundle the loans by doing a construction-to-permanent financing loan. The main benefits from using a construction-to-permanent loan program are that it reduces the number of loan applications and closing costs. With a construction-to-permanent loan program, you should also have the ability to lock in a mortgage rate today, but you're likely to have to pay for that privilege. One problem with bundling the loans is that the mortgage is typically limited to the land and construction costs. Another problem is that it eliminates your flexibility to shop mortgage rates.

To avoid private mortgage insurance on the mortgage you need to have a loan-to-value of 80 percent or less. The appraised value of the property should ideally be more than the sum of the land costs and construction costs. If you've invested $50,000 on $245,000 in costs and the home appraises at $245,000 or more, then you've made the 80 percent loan-to-value target and won't have to pay mortgage insurance even with a construction-to-permanent loan program.

All this ignores applying the equity you have in your current home toward the new home. If you don't plan on selling your existing home until the new home is completed, you can still tap the equity by either taking out a home equity loan or a bridge loan. It comes down to closing costs and rates, but you need to make sure there's not a prepayment penalty on the home equity loan. But either type of loan would eventually be paid off from the proceeds on the sale of your current home. You won't be able to get 100 percent of your equity out with either loan, but it will give you a much larger down payment. Private mortgage insurance won't even be a consideration.

What are the advantages to converting a construction loan to a permanent loan?

This is what's known as a construction-to-permanent loan. The advantage of this type of loan is that there's only one loan application and one loan closing. The idea is that the lender finances the construction of the home, and when it's ready for occupancy, the loan is converted from a construction loan to a mortgage.

there is a price for that convenience. ONe is a captive customer and there is not a lot of negotiating leeway when presented with the interest rate on the permanent financing. Decisions about the loan term and fixed vs. adjustable mortgages are made when one closes on the loan prior to construction. the borrower is also assuming a financial risk that the house is well-built.

A one-closing loan will typically be priced with interest rate locks that limit the interest rate on the permanent loan. Alternately, the loan can have a float-down option that will let the borrower take advantage of declining interest rates. A float-down option can have an interest rate floor that limits how low the interest rate can go.

If one can get a better rate by finding a new lender, then refinancing can make sense. Whether or not a construction loan is converted to permanent financing before refinancing depends on how long a window there is before the construction loan has to be converted.

one must review the loan papers and any rate lock agreements to make sure there aren't any prepayment charges, minimum loan term commitments, considerations of payback period or other charges or penalties. If there are, then the decision to refinance becomes more complicated, and a real estate professional should be hired to to help with evaluating the decision.