Forward Builder Commitments and Spot Commitments

As the U.S. economy continues to recover, mortgage rates will inevitably begin to rise. To protect their current and future inventory, homebuilders are entering into Forward Builder Commitments with mortgage lenders. Essentially, these “put options” are sold to a builder for a fee wherein the mortgage lender agrees to fund loans at a specified rate and price for a given set of loan programs over a longer-than-normal period of time (e.g. 9 -12 months). For the builder, the commitments represent an insurance policy against the possibility that higher mortgage rates will result in lost sales or “kickouts”.

For example: let’s assume that a builder wants to protect $20 million worth of home sales in a housing development they are constructing that should begin closing 6 months from today and finish closing 12 months from today; today’s rates are 3.875% at -1 point for a 30 day lock on FNMA 30 year fixed rate loan. Under a standard builder commitment, a mortgage banker may offer a 12-month agreement to fund loans for clients of the builder @ 4.25% @ -1 point or lower for up to a year for an upfront fee of 1 point. If during the commitment period rates are lower and loans are ready to fund, the builder commitment capped loans would be locked as normal to the daily rate sheet (at today’s rates 3.875% and -1 point); if rates were higher, say 5% and -1 point during the period, then the buyer’s loan would be locked in @ 4.25% and -1 point according to the forward commitment pricing. This tool allows the builder to guarantee that they will have affordable financing available to their buyers in the event the market turns for the worse in a rising rate environment. Builders who purchase these “puts” will have a competitive advantage in their market by being able to advertise and offer this type of financing to their buyers.

Next, let’s examine the effects of rising rates on borrowers and affordability. Rising rates can be a significant factor in home affordability and can make or break a deal. For example, a buyer who qualifies for a $500,000 loan at 3.875% will have monthly principal and interest payments of $2,351. If market rates increase to 5.75%, the monthly P&I payments jumps to $2,917 – a $620 monthly increase! The higher rate increases the cost of the home to the buyer, kicks some buyers out from qualifying, and generally reduces the appetite for those in the market. At a discount rate of 5.75%, the builder would have to lower the cost of the house by approximately 15% to compensate for the higher costs to the borrower.

Newer entrants to the mortgage banking industry have yet to experience a rising interest rate environment. Forward builder commitments are just one of the many tools that can be used to determine pricing and hedging on rates and fees over longer periods of time., Other tools like a Spot Commitment, wherein a mortgage lender offers float down pricing to individual buyers/borrowers, is also an effective tool but differs in that they are sold on an individual loan basis with shorter commitment periods.

If you would like to learn more, reach out to Dean Brown, Mortgage Capital Management”s CEO at
dbrown@mortcap.comor 858.483.4404 EXT: 101.

© 2017 Mortgage Capital Management, Inc.