Borrow From the Builder's Lender?

November 6, 2000, Revised November 8, 2006, January 29, 2007, February 23, 2014

"The broker at the builder’s office where I am purchasing a home told me that I had to take my loan from her. Can this be true?"

No. While the builder can require that you be qualified by his preferred lender, you are free to borrow from whomever you please.

However, offering inducements to use a preferred lender is legal if it is done properly. A builder cannot post a sale price of $290,000 and raise the price to $300,000 if a buyer insists on using his own 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 a difference!

"The builder said that he had gone to great trouble getting his houses approved by the Federal Housing Administration. And that I would be foolish if I did not take advantage of the favorable terms available on FHA loans from his associated lender. Is he right?"

Maybe, maybe not, depending on whether you need an FHA-insured loan to buy the house.

Builders targeting moderate-income home-buyers often find it useful to have their homes approved by FHA. FHA eligibility expands their market to include potential buyers who can’t make much of a down payment and don’t have good credit. If you are one of those, go with FHA.

But if you can put 5 percent or more down and have good credit, you have no reason to pay the higher mortgage insurance premiums on an FHA. Shop for a conventional mortgage.

Even if you do need an FHA, the builder’s preferred lender may not be offering the best deal. The interest rates and points on FHA mortgages are set by the market, not by the government. To protect yourself you need to check the preferred lender’s quotes against those available from other sources -- such as this site. This comparison will be complicated, however, if the builder compensates for a high mortgage price by offering a price concession on the house.

In developing a strategy for dealing with a builder pushing an in-house loan provider, it is useful to know where the builder is coming from. He expects to make money on the lending operation but the main reason for having a preferred lender is to provide assurance that home sales won’t fall through because of lack of financing.

The builder wants to avoid investing significant marketing dollars in finding a buyer, 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 arrangement with the builder. While the arrangement can take many forms, the thrust of it is that in the event that a loan to a buyer can be closed only at a loss, the loan will nonetheless be made, since the profit margin on the house will more than cover it.

For example, if the buyer turns out to have previously undisclosed credit problems that make him unacceptable except at sub-prime loan terms, the in-house lender will make the loan and sell it at a loss.

To make up for these losses, other buyers are over-charged. Since the builder cannot require buyers to use the in-house lender, he encourages them to do so by offering concessions that he hopes buyers will value by more than the over-charge. For example, if the loan over-charge is $2500, the builder might offer kitchen cabinets with a retail price of $3,000, but which only cost the builder $1,500.

It is a mistake for a buyer to commit to a builder with an in-house lender without knowing the financial part of the purchase. The true price of the house when using the builder’s lender is P + O – C, where P is the posted house price, O is the overcharge on the loan, and C is the value to the buyer of the builder’s concessions. This is the price that should be used in comparing houses offered by different builders.

The extent of the overcharge on the loan should be measured in present value dollars by shopping one or more on-line lenders on the same day. If the selected loan is a 15-year FRM which the builder's lender offers at 6%, add the sum of points and all other lender charges. The difference between this amount and the comparable figure on the same 6% loan offered by an on-line lender such as those on this site is the amount of the overcharge.

The value of concessions is the value to the buyer, which could be less, perhaps considerably less, than the value suggested by the builder. If the builder’s concession is to absorb some or all of the settlement costs, the buyer should check the alleged cost savings against those shown by on-line lenders.

In comparing true prices of different builders, buyers should give the builders ample opportunity to sweeten their concessions in order to make the deal. Especially in the kinds of soft markets that were common in early 2007 and 2014, aggressive bargaining can yield a large payoff.

Some buyers may find themselves in a situation where a particular house is the best deal, despite the fact that the builder concessions have less value to them than the loan over-charges. In such case, in negotiating with builders, buyers can offer to allow themselves to be approved by in-house lenders, while reserving the right to use their own lenders. This removes builder uncertainty that deals might fall through due to a failure to fund, and should make them more amenable to the use of outside lenders.

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