One-Time Close with Float Down Lock – Build It Advantage Loan!
Considering the recent natural disasters, the renewed interest from home buyers/borrowers to build their new homes, and the relative low level of housing stock, it’s time for mortgage professionals to renew their One-Time (or Single) close product. However, with a new twist that provides borrowers, builders and lenders with more certainty and confidence that the deal will close at a profitable level.
A one-time close mortgage is a product that combines the construction loan and sometimes the lot acquisition loan, with a permanent mortgage. These loans are purchasable by the government agencies and by non-conforming RMBS buyers. The one time or single close aspect is that the borrower only pays for one closing and signs one set of documents. Hence, the deal can be used to acquire a lot and build a home or renovate a home or reconstruct a home that has been damaged. Once the deal is reviewed, the construction costs worksheet finalized, and a suitable builder has been selected, the loan amount will ultimately reflect the lower of market value of the completed home at 80% LTV or the costs to construct or reconstruct the home plus existing mortgage debt. However, in the old way of doing things the final interest rate isn’t set until the final inspection has taken place and the prevailing rate at the time is used in the permanent mortgage. Or, alternatively the interest rate is set at origination up to 12 months before the permanent mortgage through modification is recorded. In either case a big problem could present itself in markets that see interest rates increase over the timeline which can easily stretch out for a year. In the event interest rates are set at the end of the build period, borrowers are usually qualified at a rate 50 basis points higher to give protection against higher rates, but rates can easily exceed these levels leaving a problem for both the lender and borrower from both an affordability basis and a salability basis. Another approach some lenders have taken in the past is to lock in the final interest rate upon approving the deal upfront. The problem for the lender in these cases is that although the construction loan and permanent loans ends up funding as expected, when rates decline borrowers usually turn around and refinance the home right after close thereby impacting the lenders gain on sale through either repurchase due to early payoff or gains evaporate before sale leaving a lender with nothing of value after providing significant work and service.
The float down lock pricing mechanism when attached to the one-time close product provides the borrower with the worst-case rate scenario at the time of conversion to a permanent loan, protects the lender from early payoff in the event rates go down, and allows the borrower to get a lower rate in the event rates go down or stay the same during the construction period. For example, assume that today’s market rate is 4% for a 60-day lock and the estimated and padded timeline for closing a newly constructed home is 9 months. The lock terms in the closing documents would reflect a maximum rate to be offered to the borrower at 4.375% and would be equal to the lower of this rate or the prevailing market rate upon final inspection. So, if the market rate stays the same the borrower would receive 4% and if rates went down to say 3% the borrower would receive 3%. In the event rates increased to 6%, the borrower would receive the capped rate of 4.375%. The .375% premium represents the pricing cap and can be lowered or increased to help offset the price or cost to hedge this transaction. Typically, a 9-month option set with a cap at .375% above current market would cost .75 points upfront to be paid either by the lender, the builder, or the borrower. A cap set lower would increase upfront costs while a higher cap decreases upfront costs.
MCM provides clients with Float Down pricing and hedging services through its Pipeline Risk Management services. In addition, MCM provides Spot commitment and Forward Builder commitment pricing and hedging services. The One-time close float down is something every mortgage banker should have in their product offerings! Below is a sample of the pricing for a Float Down Lock today:
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