What is a forward commitment?
A forward commitment is a homebuilder’s promise to deliver a certain amount of loan volume to a mortgage lender. A lender will lock the predetermined volume at a particular interest rate in exchange for a fee from the homebuilder.
One of the primary reasons a homebuilder buys a forward commitment is to lock in a below-market interest rate to entice future buyers to purchase their inventory homes.
Loan Officer, NMLS # 729612
Why We’re Different
There are four major reasons why our “World Domination Forward Commitment” is better than other options offered in the marketplace.
- We don’t require any up-front money. (That’s HUGE!)
- We don’t have a minimum loan amount requirement. (That’s awesome).
- We don’t have any pairing fees. (That’s amazing).
- And there’s no penalty for any unused funds. (That’s incredible).
These are MONSTER advantages for small to mid-size builders. Heck, even the “big boys” of building find this appealing. Not only do we allow builders to keep cash in their pocket, but the smaller loan commitments also allow a builder to better manage their delivery dates to the locked pipeline.
This blog outlines the mechanics of a typical forward commitment, and then notates where our “World Domination Forward Commitment” differs.
Please don’t hesitate to call us if you have any questions or want to run a specific scenario.
Major Benefits of Forward Commitments
There are three amazing benefits for builders when doing forward commitments. Those benefits are:
- marketing power,
- preserving appraised values,
- avoiding seller concession limitations.
First Benefit: Marketing and Promotion
The first benefit of a forward commitment is that the builder can advertise the below-market interest rate (and a below market monthly payment).
For example, if the market interest rate for a 30-year-fixed-rate mortgage is 7.5%, and the builder buys a forward commitment with a 5.5% rate, the lower interest rate and lower monthly payment may attract potential buyers.
Second Benefit: Preserve Appraised Values
The second benefit of forward commitments is that the cost of the forward commitment is not shown in the purchase contract or on the Closing Disclosure (CD).
This means that the appraisal will not deduct any value for the concessions. Moreover, after a home closes using the forward commitment rate, that comp will be available for future purchases and not reduce the “base” price since the rate buydown costs are not considered as seller concessions.
Third Benefit: Limitless Concessions
A third benefit of forward commitments are that the costs are not factored into the seller concessions limitations. Various loan programs (like conventional, FHA, VA, USDA, etc.) have different limitations for seller concessions.
As mentioned above, the cost of the forward commitment is not a part of the contract and not considered a seller concession. Ultimately, a builder no longer needs to worry about what loan program the buyers chooses and the program’s seller concessions limitations.
Forward commitments are often locked in 30-day intervals. Most locks are done for 60 to 120 days. For the “World Domination Forward Commitment”, the maximum period allowed will be 60 days. Therefore, in the example below we’ll use a lock period of 60 days.
No minimum loan amount with our forward commitments
Our forward commitment program does not have a minimum amount for the blocks. This is not normal (in a good way).
Minimum commitment blocks with other lenders
Most lenders will require a $3,000,000 or $5,000,000 minimum commitment from a builder. Some lenders may allow a smaller block, like $1,000,000.
These larger blocks would obviously increase the obligation costs required from the builder using a traditional forward commitment.
Conversely, our program does not have a minimum amount for the block. This allows builders to take out smaller “chunks” more often and better manage their pipeline. For example: a builder can take out an $600,000 commitment with our forward commitment program.
Gone are the days where six homes need to be delivered on the same timeline. Instead, the blocks can be taken out to accommodate two or three homes.
Example for up-front costs a “traditional” forward commitment
Builder forward commitments are made in blocks. This means that the builder must anticipate the total dollar amount needed for future loans AND anticipate the borrower profile.
For example, let’s assume a builder has five completed (or soon-to-be completed) spec homes. Average sales prices are about $500,000, and the average down payment for the community is around 10%. This means the average loan amount is roughly $450,000.
The builder also notices that many of its buyers have been using conventional financing with 30-year, fixed-rate loans. Their typical buyer also has A+ credit.
In this example, the builder commits to delivering $1,350,000 of loan volume in a forward commitment (or $450,000 in loan amounts x 3 home sales).
The builder then contacts the lender and inquiries about locking in a forward commitment for 60 days.
Note: even though this builder is budgeting for three homes sold, there is no limit to the number of homes sold to fulfill the $1,350,000 commitment. Five loans can be made at $400k, $200k, $350k, $250k, and $150k to fulfill the $1,350,000 commitment.
It’s loan volume that matters, not the unit count.
Forward Commitments are Loan Specific
A forward commitment is a block of a single loan product. Meaning, every loan in the forward commitment must be the same loan type and the same duration.
In the example above, the builder chose to lock a 30-year, fixed-rate, conventional loan. However, the builder could have secured a block of FHA loans, VA loans, or USDA loans.
Another scenario is that the builder could have reduced the conventional block to $750,000 and then executed another forward commitment for $600,000 with FHA financing, thus totaling the same $1,350,000 in loan volume.
The builder obviously needs to predict what financing may be used to fully utilize the forward commitments.
No up-front costs of forward commitments with us
This is section where we “drop the mic” and totally dominate. This is the major differentiator between us and other mortgage lenders.
Up-front fees with other lender’s forward commitments
Most other lenders will require up-front money from a builder when executing a forward commitment. This is because there is a cost associated with locking the commitment.
The cost of the forward commitment is determined by the current market interest rate and the desired rate that the builder wants to obtain. Typical forward commitments require the builder to pay for the forward commitment within 48 hours of locking in the interest rate.
For example, let’s assume that current interest rates are 7.5% for a 30-year-fixed-rate conventional loan. A builder wants to advertise and offer a 5.5% interest rate.
The builder conveys to the lender that its typical buyer has A+ credit and puts down 10% for a down payment.
The lender then determines that a 5.5% rate cost of 4 points (which is 4% of the block) for that buyer profile. Continuing with our example above, the $1,350,000 block would then have a fee of $54,000 (which is $1,350,000 times .04).
With other lenders this fee is typically due within 48 hours of locking the interest rate. But not with us!
Using our “World Domination Forward Commitment” program, this fee is payable either 48-hour AFTER CLOSING, or within 48-hour of the lock expiring. This is incredible!
We will repeat because it’s that huge: our program does NOT require that the builder immediately pay $54,000. Instead, we’ll allow the builder to realize revenue from closing before requiring the funds!
Forward commitments do allow for a one-time lock extension of 30 days at a cost of 50 basis points (which is .5%).
Note: since our builder forward commitments don’t have any penalties for unused funds, a builder doesn’t have to extend the rates if the market has remained flat or improved. A builder can simply let the lock expire and then open a new commitment.
Lock extension example
Let’s assuming in our example that on day 55, only $900,000 of the initial $1,350,000 block has been used by closed loans. The remaining $450,000 block expires in 5 days (55 days + 5 days = the total 60 days).
In our example, the builder has now paid the lender $36,000 of the original $54,000 cost that was due for the $1,350,000 block. The $36,000 is calculated by the $900,000 of used loan volume, times 4% costs for the block, equals the $36,000 that has already been paid after closings.
This means that if the builder lets the lock is in 5-days, they’ll owe the remaining cost of $18,000 (which is from the $54,000 minus $36,000) if they don’t extend the lock before 48-hours of expiring.
In our example, we’ll assume that the builder (wisely) decides to extend the lock. The lock extension cost will be based off the remaining commitment of $450,000 ($1,350,000 block minus the used $900,000 loan amounts).
The cost for the one-time, 30-day extension at 50 basis points is $2,250 ($450,000 times .005). This now allows the builder to find another buyer (or two) to use the remaining $450,000.
No Tolerances Penalties with Us
Our forward commitments do not issue any tolerance cures for unused funds once the lock expires. This is not normal and amazing.
Tolerance penalties with other lenders
In the example above using a “normal” forward commitment, the builder committed to $1,350,000 in loans to be delivered to the lender before the initial lock expiration date (which is 60 days in our example). After using their one-time 30-day extension, they have 90 days to fully use the initial $1,350,000 block.
Obviously, funding the exact amount of loan volume equal to the block is challenging since neither the builder, nor the lender, knows what loan amounts the unidentified, potential buyers will need. Because of this, lenders allow a tolerance.
In this example, we’ll use a 2.5% tolerance. This means the builder can deliver +/- $33,750 of the initial block. In other words, the builder can fund as little as $1,316,250 in loans (which is 97.5% of the initial $1.35M block) or as much as $1,383,750 in loans (which is 102.5% of the $1.35M block).
Ultimately, none the information is pertinent for our forward commitments program. We do not have any penalty for unused funds.
No Pairing Fees for Us
For our “World Domination Forward Commitment” program, we won’t issue a pairing fee. This is amazing! Below is an example of what a pairing fee may look like with other lenders.
Pairing fees with other lenders
The builder avoids a “pairing fee” if they deliver a total loan volume between the high and low tolerances. In our scenario, the tolerance thresholds are $1,316,250 and $1,383,750.
A pairing fee is often 50 basis points (which is .5%) of the amount that is outside the allowed tolerances. In the aforementioned example, let’s assume the builder only funds $1,200,000 of loans after 90 days (based on the 60-day locked period and the 30-day extension).
The funded $1.2M is $116,250 less than the minimum tolerance of $1,316,250.
For a typical forward commitment, the pairing fee that the builder pays the lender is $581 ($116,250 times .005). This covers the cost of the unused portion of the forward commitment block.
Conversely, in a different example, let’s assume the builder funded $1,400,000 of loans. This exceeded the upper threshold of $1,383,750 by $16,250. In this scenario, the pairing fee would be $81.25 (which is $16,250 times .005).
As a reminder, we do not charge any pairing fees for our forward commitments.
No Final Pay-Up Fees with Us
Because our “World Domination Forward Commitment” does not require up-front costs, there may be a final amount due when closing out the commitment.
Final pay-up fees with other lenders
In the presented example, an initial block of $1,350,000 was locked at a cost of 4% (or $54,000). If the builder only closed $1,200,000 of loans, this means that only $48,000 of the $54,000 was paid after closings.
As previously stated, the “up-front” costs will be due either 48 hours after closing OR within 48 hour of the lock expiring. This means that if the remaining $6,000 will be due to the lender within 48 hours of the lock expiring. ($54,000 for the initial costs minus $48,000 that has already been paid).
Borrowers May Have Different Interest Rates
A forward commitment offers a specific rate that is below market (thanks to the builder’s buying down the rate). However, this does not mean every buyer will end up with the marketed interest rate.
Forward commitments are locked on an assumed buyer profile. In our example above, the builder locked a conventional rate with the assumption of a 10% down payment and A+ credit profile.
A buyer that utilizes the forward commitment may have a higher interest rate if they put less down than the assumed 10% downpayment, and/or have credit lower than the assumed A+. Despite these adjustments, the borrower’s rate will still be considerably lower than the current market rate thanks to the builders buying down the rate.
The Rate is Transferable
The cool part about forward commitments is that the rate is transferable. This means that the rate can be given to any borrower (that qualifies for the loan program) and be used for any home.
For example, the Smith wants to purchase 123 Main St, a completed spec. The builder’s lender starts the process with this buyer. Then, three weeks into the process Mr. Smith loses his job. He no longer qualifies for the home loan.
While this is unfortunate for Mr. Smith, the builder and lender can reassign the forward commitment to the Ramirez family buying 567 Elm St.
The forward commitment is not specific to a person or a property.
Warning: Worst Case Scenario
Let’s take an absolute worst-case scenario for a builder. Let’s pretend the builder doesn’t close a single loan during the first 60 days. The builder then pays for a rate extension (assuming they want to keep the rate because the market has gotten worse for buyers). And finally, let’s pretend the builder doesn’t close a single loan the entire 60 days before the lock expires.
Using the numbers from the previous example, the builder takes out the $1,350,000 initial block with a cost of 4%. The builder is now on the hook for the $54,000 fee.
The lock is good for 60 days but the builder hasn’t closed a single home. The builder then extends the rate for 50 basis points. The one-time, 30-day extension is $6,750 (which is $1,350,000 for the unused loan amount times .005).
Sadly, by day 118 the builder hasn’t sold a home. At this time, the builder would owe the full $54,000 fee to the lender.
We sincerely hope that this worst-case example never happens.
This “World Domination Forward Commitment” program is an extremely powerful tool. We strongly recommend this program for completed specs and nearly completed specs. The worst-case example above shows the danger of projecting closing dates that may get pushed.
Because there are no minimum requirements for the block amounts, we strongly recommend waiting for a firm closing date before executing a forward commitment. There’s no harm in doing smaller blocks if a bulk of homes won’t be delivered at the same time.
Lastly, don’t assume every buyer will do the same program (or need financing). In the example used, the builder had five specs available, but only predicted that three of the five would be needed for financing. This provides “wiggle” room in case some buyers pay cash or utilizes a different loan program.
The Mortgage Mark Team is here to help. Please contact us if you have any questions and we’ll be happy to guide you through the process.