Inducements to Use A Builder's Lender for a Purchase

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One of the things I'm seeing more of in MLS listings and developer advertising, among other places, is the phrase "$X in closing cost credit (or "$X in free builder upgrades") given for using preferred lender"

Sounds like a bargain, right? Just use their lender and you get this multi-thousand dollar credit. After all, "All Mortgage Money Comes From The Same Place!" Free money, right?

Well possibly, but not very likely. What most companies are looking to do with this advertising is give people a reason not to shop around. They hope that because most people think that "All Mortgage Money Comes From The Same Place", the average customer will just stay there to apply for a loan. Many builders and conversion companies will throw roadblocks in your way if you try to use another lender. They cannot legally require you to use their loan company (at least not in California), but they can make it exceedingly difficult to go elsewhere. I've been told by builder's representatives on two occasions that I was wasting my time with a loan, because "If they don't use our lender, they won't get the property!" despite already having a signed purchase agreement. Roadblocks take all sorts of turns. They won't let the appraiser in. They won't cooperate with requests for information, without which the other loan is going nowhere. And so on and so forth. By the way, this behavior is illegal under RESPA. They're just betting you won't do what it takes to complain, not to mention that even if you do complain you're still not likely to get the house you wanted - the genesis for all of this.

I should mention that the concept of giving you incentives (metaphorical carrots) instead of metaphorical sticks is legal, ethical, and highly desirable as opposed to the behavior in the previous paragraph. Just remember they've got to pay for those incentives somehow. Builders are not charities. You still want to shop your loan around based upon the bottom line to you.

The builders wouldn't give those incentives to use their lender, or throw roadblocks in your way when they're trying to sell you a property, if they weren't making more money with the loan. Quite often, they're making more money on the loan than they are from the sale. Put you into a loan half a percent or more above market, stick a three year prepayment penalty on it, and voila, anywhere from a 6 percent premium to perhaps 10 percent. To give you a comparison, around here an agent makes 2.5 to 3 percent from a transaction, and I do my loans on a margin that varies from under half a point to a point and a half, depending upon difficulty and size, and discounted from that if I'm also getting an agency commission on a purchase. But the average consumer is distracted by these "free" upgrades or closing costs that they don't realize how badly they've been raked over the coals. If I can get you that $400,000 loan half a percent cheaper and with no prepayment penalty, I'm saving you $2000 per year for certain, and very likely about $12,000 on the prepayment penalty.

Furthermore, on some of the builder's loans I've analyzed, they're getting you a rate that would carry a point and a half retail rebate or more, even without the prepayment penalty. This means on a $400,000 loan at that rate, the lender would be paying you a $6000 incentive to do that loan, more than covering normal closing costs. But this is comparatively rare. Usually, they're earning some or all of the secondary market premium directly. Have no fear, that builder is doing quite well for having loaned you that money.

What can an average person do about this sort of thing? As I've said before, builders often throw roadblocks in the way of outside lenders, and there's not a lot that you or anyone else can do about this fact.

There is a bill in the California legislature that wants to ban developers from being the lender also. This is a "quick fix" that won't fix anything; in fact, it will hurt. They can bring in outside lenders who agree to pay them under the table, or even on out in the open for certain services. Net benefit: Zero. However, this bill would also make it more difficult for buyers to order custom upgrades and finance them into the cost of the purchase, as often happens now and can be highly beneficial to the consumer who goes in with their eyes open. I wouldn't be surprised if it was the developers themselves pushing the ban.

Many people want brand new homes if they can get them. Given the realities about Mello-Roos and how prevalent homeowner's associations are in more recent developments, I'm not certain I understand this. It's one thing to deal with Mrs. Grundy when you're all cheek by jowl in a condominium high rise. It quite another thing to deal with her complaints because you left your garage door open ten minutes longer than the rules say, you want to paint your detached home a couple shades darker or lighter than everyone else, or whatever's got her dander up today.

I do have a trick or two up my sleeve for when I'm a buyer's agent in new developments. It's my job to outmaneuver the selling agents the builder has on staff (who tend to be heavy hitting salesfolk, which is not the same thing as the stronger agent). But they are dependent on some things that change from transaction to transaction, so I can't really describe them in any kind of universal terms. Writing an offer contingent upon an outside loan has its limits. Builders who throw roadblocks have that one wired; they wait for the contingency to expire at which point they've either got your deposit or your loan business as you are so desperate not to lose your deposit you'll do almost anything, particularly since most folks don't understand how much that loan is really likely to cost them.

Caveat Emptor

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In Bergen County were I sell and build, there are only local builders. I have used and still use creative buy downs and the like. I really don't require anyone to use my company. The buy downs costs are pretty straight forward, it is only a mathematical equation. Many buyers will wave the incentive and take the reduction in price. Why a builder would give a hard time to the buyer on where they borrow the money, doesn't make sense. Maybe the builders own the mortgage company. They may share in the revenue from the underwriting. I read about this in the past. I think the writer was saying that the real cost were not as it was thought to be. The expenses and percentage rates were not as low as thought.
That is just stupid though. I have had many home buyers, hundreds. They always see the disclosures; I always make sure that the buyers are aware of the costs and the APR. I am sure other agents do the same. If a builder try’s that kind of hanky panky, the buyer should not do business with them at all.

Dan Melson Author Profile Page said:

"Seeing the disclosures" is an entirely different thing than shopping competitively for the best rate. The worst crook in the world can (and usually does) show the disclosures. From my experience, a builder's Good Faith Estimate (or MLDS in California) is no more accurate than they typical loan officer's, which is to say not very. Often, it's even worse, See this article The Good Faith Estimate for more and How Much Can Lenders Low-Ball Their Quotes? for more.

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This page contains a single entry by Dan Melson published on December 7, 2013 9:00 AM.

Recording Errors and Title Insurance was the previous entry in this blog.

Saving Money by Refinancing Your Mortgage is the next entry in this blog.

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