This week the Federal Reserve announced that interest rates might be rising higher and faster than earlier projected. For many considering building or buying a new home, it raises the question, "will we be able to afford a loan?" It's a fair question - a change in rates can make a big difference. A one-percent increase on a 30-year, fixed-rate, $350,000 mortgage can increase your monthly payment by about $200.
For people looking to build a new home, this uncertainty is made worse by the fact that the home-building process takes about year (or more!) from beginning design to move-in. What happens if you start designing your dream now, only to find out you can't afford it later because rates spiked between your initial appraisal and final closing? To address this, several lenders have begun offering one-time closings, which locks in your mortgage rate at the beginning of construction, giving you the peace of mind that you won't be hit with surprise rate hikes when your house is complete.
While you should always consult your lender for financial information, some basic Q&As about one-time closings are below, plus additional information on how Building as Partners' design, budgeting, and construction processes can help protect you from risk. Click below to jump to a section, or just keep reading!
How Does a One-Time Close Differ From a Traditional Construction Loan?
In a "traditional" 2-close construction loan, the Owner will go through two appraisal, underwriting, and closing processes. The Owner signs an interim construction loan at the current market interest rate. Their final mortgage rate is locked in at the end of the project at the current market rate, which might be higher or lower than their interim rate.
In a 1-time close, the Owner goes through just one appraisal, underwriting, and closing process. The Owner's mortgage interest rate is locked at the current market rate at beginning of the project.
What are the Risks / Benefits of Each Type of Closing?
Traditional (Two-Time) Close:
If market interest rates drop, Owner benefits from the lower rate at the completion of the project.
More flexibility for changes to the scope of the project throughout the job
For example, if your initial plans included a fence and extensive landscaping, but you decide at the end of the project to save money by doing that work later, you can decide not to do it. The final appraisal just won't include those items.
More flexibility in final loan amount
If a project comes in under budget, the Owner only borrows the amount spent on the project.
If a project comes in over budget, many traditional construction loans allow for a percentage (usually about 10%) cushion for change orders or cost overruns.
If market interest rates increase, Owner will sign at the higher rate at the completion of the project.
Owners have to apply and qualify twice - once for the interim loan, and once for the mortgage. Gathering documentation to apply twice can be time consuming (and risky if personal financial situations change over the course of the build).
The final loan amount approved will depend on the final Appraisal. If the Appraisal comes in lower than the initial (interim) Appraisal, the lender may not approve the full amount of the loan. If this happens, the Owner will be required to make up the difference in cash.
Two closings means two sets of closing costs. Some lenders may lessen closing costs to ease this burden, but these costs must be factored into both closings.
If market interest rates increase, Owner benefits from the lower rate that was locked in at Appraisal.
Owners only have to apply and qualify once for a loan.
The home value is determined at Appraisal, rather than at the end of the build. This protects the Owner from needing to bring additional cash to the project due to valuation surprises.
Owner only pays one set of closing costs.
Once the project is complete, paperwork is minimal and Owner can move in without delay.
If market interest rates decrease, Owner will still have the higher rate locked in.
Less flexibility for changes to the scope of the project throughout the job, since the home's value (and therefore the approved loan amount) is based on the project as described and appraised prior to construction starting.
For example, if your initial plans included a fence and extensive landscaping, and those were part of the Appraisal, you must have that work completed before the lender considers the project finished.
Less flexibility in final loan amount.
The loan amount is set at Appraisal, so any overruns will be paid in cash by the Owner.
However, some lenders may offer a one-time adjustment (for example, some lenders allow you to lower your overall principle if you plan to sell your existing home closer to the end of the build, and want to put that money straight into equity of the new home).
How Can Owners Protect Against the Risks of Either Type of Closing?
Regardless of which closing type you choose, there is always some amount of risk when you build a new home. Many builders think of these risks as "inevitable." But Building as Partners believes that with the right questions, planning, and knowledge, we can help Owners mitigate many of the risks inherent in the building process.
Thorough Design & Detailing Processes Before Breaking Ground
Our Design Process goes beyond the typical "draw a floorplan the Owner likes." We walk you through the details, from everything from door swings to cabinet drawings, to make sure you are as prepared as possible to go into appraisal. And we update your pricing every step of the way.
We know you won't finalize all your decisions before construction. It's an impossible ask. But our goal is to make sure the big cost drivers are known and addressed early so to avoid sticker shock during the build. You will also know what decisions are pending, which will allow you to manage your budget and decisions accordingly.
Budgeting From Day 1
Proper budgeting is important for any build, but especially crucial for one-time closings. A thorough Design Process means thorough budgeting based on your specific design. Building as Partners begins building your budgets from Day 1, and we refine them as you design your home. By the time you're ready to go to Appraisal, we'll have budgets ready for yours and your lender's review. By the time you're ready to start Construction, we'll have full construction budgets prepared for the build. During the build, we'll update your projected Cost-to-Finish so you always know how you're doing against your budget.
Clear Deadlines and Diligent Construction Management
Some of the "hidden" costs of construction are those due to last-minute changes, or decisions made at the wrong time. Once Construction begins, you'll have clear "Owner Deadlines" for any outstanding decisions to be made. This ensures we can move the project forward on schedule and lessen those costs arising from last-second changes or requests.
Your construction schedule and deadlines will be posted in our online project management system, which you'll have access to throughout working with us. We'll post pictures, update the schedule, and call out specific questions for you to answer as we build your dream.
Regular Updates to Our Pricing Model
The soaring labor and material increases of 2020-2022, and later drop in lumber, have made regular budget updates crucial for builders and Owners. We work hard to make sure our jobs purchase materials at the best prices possible, and hire quality subcontractors at fair prices. To do that, we:
created internal systems to confirm lumber prices weekly, so we know when things are trending up / down and can buy accordingly;
work with vendors to identify upcoming sales or special offers on top of the already-lower builder pricing we pass on to our customers;
regularly check in with our subcontractors to ensure our pricing is up-to-date; and
have connections and resources to price "one-off" specialty items customers might ask for that are not part of our regular pricing update.
This means that we can adjust our estimates to ensure the most accurate budgets possible for Owners, both before and during construction. This helps Owners always know where they stand, and how they might be able to adjust decisions based on that knowledge.
So...Which Closing Type is Right for Me?
That's the million dollar question, and while we'd love to have all the answers, we never will. Much of the answer comes down to what level and kind of risk you are comfortable with, and how you expect the market to change during your build timeline. But hopefully, armed with the information above, you can work with your lender to make the right decision for you and your family. If you need recommendations for lenders, please contact us and we can provide you with both traditional and one-time close lenders to talk to and learn more.