the builder-directed financing hook . . . ouch.

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“Hey look, a fantastic new house with the builder paying $5,000 in closing costs!  What a great deal! . . . (mouth open in awe and in excitement of the ‘generosity’ of builder) . . . Ouch!  What the heck was that!! (pain invoked by small print and/or asterisk next to the $5,000 in closing costs* only paid with approved lender)”

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In the Atlanta-market (and likely in other markets around the county) builder-directed financing has become the norm.  The builder will pay for some of your closing costs only on the condition that you use a lender from “their approved list.”

There are four different reasons why this is the case — one is legitimate and legal; the second is usually illegitimate but is perfectly legal; the third is both illegitimate and illegal; the fourth is legitimate and legal (although unlikely).

Scenario number one:  The builder has the same name as the mortgage company and is owned by the same entity (legitimate and legal).

If the builder has the same name as the mortgage company (i.e. ABC Homes and ABC Mortgage, etc.), the incentive of you using their mortgage company is a business decision and is an impossible battle to fight.  If you have signed a contract agreeing to this type of arrangement (that the builder will pay closing costs only if you use their mortgage company — which by the way, is probably the only contract available if you want to purchase one of their homes), then the hook has been well-set and the best you can do is prepare yourself.  You will not get a great rate — usually a 0.25% to 0.5% higher than the market rate; you will not get great service — usually phone calls are returned within days instead of hours; and you will not get much service after closing.  But hey, if you love the house, then you love the house . . . what’s a fish to do? 

Here’s an example:  You purchase a $250,000 from ABC Homes and are putting down 20%.  The builder agrees to pay $6,000 in closing costs/prepaids with their “in-house” mortgage company, ABC Mortgage.  On a $200,000 loan amount, a rate increase of 0.5%, will cost you $65 more per month . . . and a total of $23,400 over the life of the loan.  If you were to stay in the house for only 7 years, the additional cost would be just over $5,460.  ABC mortgage company is smart enough to know that you’ll jump-ship if the rate is too-too high, but for $6,000 in closing costs, seems harmless, right?  That’s what the fish said to the little pink worm with the weird-barbed-shinny things on it’s belly.

Scenario number two:  the builder has formed a joint-venture with a mortgage company (not usually legitimate, but perfectly legal . . . for now).

By definition, a joint-venture is a legal organization (a partnership) in which the companies (or persons) jointly undertake a business activity for mutual profit.  It  implies the sharing of costs, of resources, of expenses and of operations. 

Mortgage companies have been forming alliances with builders and real estate companies(legally set-up as joint-ventures) over the past 5+ years.  More recently, it seems to have become the norm for builders.  IF (and I use the word “IF” with great emphasis), if there is a legitimate sharing of costs, resources, expenses and operations, then the joint-venture is similar to the scenario number one.  If it is simply a means/avenue where the builder can share referrals and the mortgage company can kick-back a few $$ per transaction to the builder, then it is completely against what the Real Estate Settlement Procedures Act (RESPA) set out to do — according to Section(8)a of RESPA, it is illegal to accept anything of value in return for the referral of business. 

This is a BIG subject . . . one that deserves it’s own post.  More on RESPA-violations later.

Scenario number three:  the builder is receiving “something of value” in exchange for the referral of business (illegitimate and illegal . . . although quite popular in the past).

Somehow mortgage companies justify this type of arrangement by contributing $$ to a “builder’s marketing fund.”  Sounds like “something of value” and a violation of RESPA, right??  Apparently, there are attorneys who would say otherwise.  A few years ago, an agent (after having a great experience with me) really, really wanted me to get connected with a builder-friend of hers.  I am not exaggerating when I say that the phone conversation last no more than 2 minutes.  He said … “Hello . . . this is ____, I wanted to talk to you about being one of our preferred mortgage folks.  How much do you contribute to a marketing fund per closing?”  After a brief comment or two about my thoughts on RESPA and my desire to keep the law, he politely ended the conversation.  “Well . . . I know you may say it’s illegal, but plenty of people are doing it.  Ok.  Bye.” (click).

Scenario number four:  the builder is preferential to one or two certain mortgage people and is so convicted by their professionalism and friendship that he/she will only pay closing costs if you use one of them.

Because there is no $$ value associated with this type of scenario (allegedly), the choice of the buyer to use one of the “preferred” mortgage company vs. another company should have absolutely no financial impact on the builder.  However, there is a rather common practice (for example) where the builder agrees to “pay” $4,000 in closing costs because the mortgage company intentionally increases the interest rate charged to the consumer and then pays for some of their closing costs for them.  One builder was even bold enough to write this in his contract, although in very small print — that half of the closing costs would be paid by the builder and half of the closing costs would be paid by the lender.

If you have signed a contract under any scenario above, then you are hooked.  You have agreed to it in writing . . . if you use a preferred lender, you get $x,xxx in closing costs . . . if you don’t, you don’t.  You can try your best to get a great rate and great service, but I would shoot more for a good rate and decent service.  You can do the math just for fun — “a higher rate, times 5 years, versus $3,500 in closing costs, means you’ll break even in x years.”  But the preferred lenders are no dummies, if the dollar amount from the builder is $4,000 in closing costs, they know that they can make you $3,999 angry — just not $4,0001 dollars angry.    

The ONLY legitimate scenario is one in which the builder will pay for your closing costs regardless of who you use for your mortgage financing (assuming that you can prove that you are qualified and able to get financing).  The best situation is one where the builder strongly and personally recommends one or two mortgage providers and then allows the consumer (and competition) to decide the outcome.  Some builders will argue that directing where the mortgage is being placed allows them to “keep an eye on things”, “they know it’ll get done”, etc . . . a builder not closing on time and it’s the mortgage company’s fault??  Yeah, only if by “mortgage company” they mean the — (pick one) landscaper’s, painter’s, counter-top guy’s, punch-list guy’s, hardwood floor company’s — fault.

How about this . . . you choose who you get your mortgage from and you guarantee to the builder that you’ll close your mortgage on-time if they guarantee to have your house ready in time?  It is a GREAT concept and there is a GREAT builder — Harcrest Homes — who has done it for years.         

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2 Responses to “the builder-directed financing hook . . . ouch.”

  1. mike Says:

    nice blog!

    mike

  2. Surprise, Surprise, Surprise . . . builder directed financing creates ethic questions « The Mortgage Blog Says:

    […] amount of closing costs only if the buyer uses their “preferred” company.  I have posted at length in the past on this topic — and outlined the different scenarios.  But […]

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