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Cheops' Law
Cheops was Pharaoh of Egypt ca. 2650-2630BC, and builder of the Great Pyramid at Giza.
His first law: "Nothing is ever built on time or within budget."
April is construction season, and explosively so in Boulder County, where perhaps 2,000 new homes will be built in 1998AD. Therefore, here follows a discussion of the conflict between an unknown date for completion and the need for interest rate protection; and a workable -- if uncomfortable -- solution. In offering these thoughts, I do not mean to insult the mortgage and building industries. Much.
Construction of a large home can take a year; for most homes five to nine months is more like it. All mortgage lenders can offer interest rate commitments for at least nine months in the future, but none are particularly useful for two reasons: cost, and uncertain completion date.
The cost of a long term (more than 60 days out) rate commitment can be expressed mostly in rate or in fee, or a balanced mixture of the two. All are hellishly difficult to de-code.
If the cost is expressed largely in rate, what you get is a ceiling: say, 8.25% for nine months out costing only a point (percent) versus today's roughly 7.25%. On the other fee-heavy hand, to secure today's rate, you'll have to pay a half point of the loan amount for every month past 60 days: if you need nine-month money, that's seven times .50%, or a 3.50% loan fee. A mixture: two points and 7.75%.
These are lousy deals. The ceilings tend to be as high or higher than rates are likely to go, which is why they are offered at low fees. The whopping loan fees for today's rate are just too much money, even if some "float down" bell-and-whistle is attached.
Further -- and worse -- you can't know if the house will really be done by the expiration of the commitment. If you're trying to buy money before construction starts, you must overlap the estimated completion date by at least a month. Two is better.
So, what do you do?
First, review Cheops' Corollaries.
The most unpredictable period of construction is the middle. Completion is easier to estimate the closer you are to completion ("duh" translates well in hieroglyph: blank face above shoulder-shrug). In the case of houses (not pyramids), you are eight to six weeks from completion when the sheetrockers show up.
The first part of construction -- hole, foundation, sill plate, framing -- go predictably fast. In the middle, the high-value-added sub-contractors -- electrical, HVAC, plumbing -- are elbowing for room, and jammed job-to-job. In mid-construction for most houses, there will be a stretch (One week? Three?) when nothing is happening because everybody is waiting for the electrician, and he's three houses behind.
The sheetrockers can't start until the fancy subs are done, but when the rockers start -- oh my! It takes years to create a journeyman electrician, but you can teach a college kid in an afternoon how to do almost any job from sheetrock to closing (tape, spackle, paint; roll in the commode, roll out carpetÉ).
A 60-45 day interval from rock to closing dovetails neatly with cheap interest rate locks. While the post-rock interval is more predictable, it's not perfect ("We can't get a clean final appraisal inspection because the tile is on a truck in MissouriÉ"). Always, always, always overlap your sheetrock-to-closing forecast with an extra 10 days of interest rate lock. Just in case.
There is little greater misery than watching a rate lock expire in a rising rate market because the house is not done. It's only more miserable if you paid for an expired lock.
Waiting until the 60-day, sheetrock mark is neat advice, but what do you do before then?
Try to relax. You can't buy protection at a reasonable price. If rates rise, consider switching to an ARM, one of the three- or five-year types, wait for rates to come down, and refinance. In the 1990's every high spot in mortgage rates has been followed by at least a one-percent drop within the following twelve months. Sure, it costs to refinance, but nothing like the cost of a long term commitment.
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