In my last post about building your dream home, I painted a gloom and doom picture of total financial annihilation for unwary doctors who stumble into an adjustable rate mortgage, thus beginning what I called The ARMs Race. Today I'll tell you how to win The ARMs Race. And the secret is...
Don't get an adjustable rate mortgage in the first place!
Really, there are other perfectly good ways to finance the construction of your dream home, and one of my favorites is what the mortgage know-it-alls call a "one close."
How the One Close Loan works... There are two phases of owning your dream home: building it, and living in it.
While you're building it, you need a construction "loan." I put "loan" in quotes because it's not really a loan in the truest sense of the word. It's actually a line of credit where the bank reimburses the builder on an as-needed (called "percent completion") basis. This way, you only pay interest on the part of the construction loan you've actually used.
While you're living in your dream home, you need "permanent" financing; what most people think of when they hear the word "mortgage."
It would be cool if you could get just one loan to cover both phases of owning your dream home, but you can't. Why? Because nobody (including your builder) knows exactly what your finished home will cost.
But you can apply for and close on the construction and permanent loans at the same time in what they call a "construction-to-permanent loan."
... and why it's so great... A one close loan lets you lock both the interest rate on the construction loan AND the interest rate on the permanent loan at the same time. This means you'll know EXACTLY what rate you'll get when you're home's finished (as many as 15 months into the future), AND if home mortgage rates rise dramatically while you're building your dream home, you won't have to worry that your payments will grow larger than your budget.
So, now that you know what you want, you can march into your mortgage broker's office, slap the hardwood top of his paper-strewn desk , and shout confidently, "I want a one close construction loan with permanent financing in a 30-year fixed product, I want a 15-month* lock, and I want it NOW."
...but why you've never heard about it. With a sly smirk on his face, your mortgage broker will stare thoughtfully out the window for a moment and then turn to you with a sigh to say, "I can do that, but it's going to cost you."
He knows that the 15-month lock is going to add up to one full percentage point to the cost of your loan (about $10,000 on a one million dollar mortgage), and he's not sure how you're going to feel about it. As I said in my last post, up-front fees like these usually cause casual rate shoppers to move on to cheaper pastures, and that's why this one close loan with a long lock date may be news to you.
You see, you can have certainty in the rate you'll pay on your mortgage for 30 years after the home's finished, and you can lock in that rate 15 months before construction begins, but somebody has to bear the risk that rates will rise after the loan is locked, but before the permanent loan is funded.
After all, mortgage interest rates are a market-driven commodity, and there's risk involved for the lender.
When you pay a fee up front to lock in the rate, it's like buying rate insurance, if you will. When you pay that fee, you're compensating the lender for the risk they're bearing.
Is this One Close financing right for your family? The answer here is "yes" if...
- The estimated price tag is near the high end of your budget
- You're believe things will come in on-time and on-budget,
- You don't mind paying a premium when it comes to your financial security, and
- You don't like to gamble when it comes to owning your dream home.
After all is said and done, you'll feel good knowing you've provided your family with a high quality home, and you'll feel even better knowing you can still afford that home for years to come... even if it costs a little more today.
* Here, I used a 15-month lock in my example. What you really want is a lock that's about 3 months longer than your builder's estimate for the time it takes to finish your house, just in case he's slow in finishing the job.