Don’t rush decision to use builder’s lender
Findingthe right home mortgage loan provider is complicated enough, but when you buy ahouse from a builder who has an in-house lender, the complications multiply.The builder wants you to use his lender, and will offer significant inducementsto do so. This puts many buyers in a quandary as they realize that theinducements must be weighed against the likelihood that the builder’s lenderwill overcharge them.
Offeringinducements is legal if it is done properly. A builder cannot post a sale priceof $290,000 and raise the price to $300,000 if a buyer insists on using his/herown lender. But a builder can post a price of $300,000 and reduce it to$290,000 for borrowers who use the in-house lender — as if there was adifference!
Indeveloping a strategy for dealing with a builder pushing an in-house loanprovider, it is useful to know where the builder is coming from. He expects tomake money on the lending operation, but the main reason for having a preferredlender is to provide assurance that home sales won’t fall through because oflack of financing.
Thebuilder wants to avoid investing significant marketing dollars in finding abuyer who then leaves him at the altar because his loan doesn’t come through.This won’t happen with his in-house lender because of some prior arrangementwith the builder. While the arrangement can take many forms, the thrust of itis that in the event that a loan to a buyer can be closed only at a loss, theloan will nonetheless be made, since the profit margin on the house will morethan cover it.
Forexample, if the buyer turns out to have previously undisclosed credit problemsthat make him unacceptable except at subprime loan terms, the in-house lenderwill make the loan and sell it at a loss.
To make upfor these losses, other buyers are overcharged. Since the builder cannotrequire buyers to use the in-house lender, he encourages them to do so byoffering concessions that he hopes buyers will value by more than theovercharge. For example, if the loan overcharge is $2,500, the builder mightoffer kitchen cabinets with a retail price of $3,000, but which cost thebuilder only $1,500.
It is amistake for a buyer to commit to a builder with an in-house lender withoutknowing the financial part of the purchase. The true price of the house whenusing the builder’s lender is P + O – C, where P is the posted house price, Ois the overcharge on the loan, and C is the value to the buyer of the builder’sconcessions. This is the price that should be used in comparing houses offeredby different builders.
The extentof the overcharge on the loan should be measured in present-value dollars byshopping one or more online lenders on the same day. I will have a detailedexplanation of exactly how to do this in the version of this article I place onmy Web site.
The valueof concessions is the value to the buyer, which could be less, perhapsconsiderably less, than the value suggested by the builder. If the builder’sconcession is to absorb some or all of the settlement costs, the buyer shouldcheck the alleged cost savings against those shown by online lenders such asAmerisave, E-Loan or IndyMac.
Incomparing true prices of different builders, buyers should give the buildersample opportunity to sweeten their concessions in order to make the deal.Especially in the kinds of soft markets that were common in late 2006,aggressive bargaining can yield a large payoff.
Somebuyers may find themselves in a situation where a particular house is the bestdeal, despite the fact that the builder concessions have less value to themthan the loan overcharges. In such cases, in negotiating with builders, buyerscan offer to allow themselves to be approved by in-house lenders, whilereserving the right to use their own lenders. This removes builder uncertaintythat deals might fall through due to a failure to fund, and should make themmore amenable to the use of outside lenders.
Thewriter is professor of finance emeritus at the Wharton School of the Universityof Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.
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Copyright 2007 Jack Guttentag
