When you first begin shopping around for the best rate and terms to finance the construction of a new rental property, it’s not uncommon to come away from the comparison with a headache. Or at least a bit dizzy.  Construction loans are short term and of the interest only variety with interestconstruction rates charges only applied when the builder makes a draw.

But rates do change, sometimes more quickly than the average investor may have anticipated. What makes interest rates move up or down, who moves them and why? This is important to understand when you get ready to lock in a rate for a construction loan.

Construction loans are pegged to a common, tradable index such as the Wall Street Journal Prime rate plus a margin, a 6-monthLIBOR or a 1-Yr CMT, which stands for Constant Maturity Treasury index. Upon setting the rate for the construction loan, the bank pulls the proper index then adds their margin. If the index for instance is the 1-Yr CMT is 0.50 percent and the bank’s margin is 2.25, then the rate for construction might be 2.75 percent.

The index changes as investors buy or sell a particular index. The Prime rate won’t adjust unless the Fed moves the Fed Funds rate but other securities will have their price change. The 6-month LIBOR can have greater or lesser demand from investors and depending upon its popularity will rise or fall. Once the index moves so too will your final rate. That is when you tell your bank to lock it in.

Banks don’t lock in your rate until you tell them to or your loan has become fully approved. Some banks lock in your rate upon application while others will let you choose when to lock. Should rates fall and you waited to lock, you win. But if rates go up and you’ve yet to lock, you didn’t. Playing the interest rate game can make you pull your hair out. Don’t be that way but instead find the most competitive rate available at the best cost and move on. The way rates are today, you can’t go wrong.