I got quite a bit of email last week after my article about the Washington, DC, new home buyer being stuck between a $68,000 rock and a $68,000 hard place. This conundrum neatly arranged by the builder and the builder's loan officer. You know the story, the one about a buyer only being able to qualify for one loan type -- a nasty, nasty one -- supplied by the builder's mortgage company in order to buy the new house. The buyer could either walk away from the deal and lose his $68,000 deposit or he could take the deal and be foreclosed upon just in time for the 4th of July parade.
My emails expressed shock, disappointment, and even a "I told you builders were a bunch of crooks" type. But one notion was never raised -- precisely "why" does a builder want a buyer to use their mortgage company? Why do they care?
If you think about it, squeezing another 1 percent out of a buyer in the form of an origination fee is hardly worth if it the buyer of the home does nothing more than complain to all their friends, the Better Business Bureau and whomever comes within a 50 foot radius about how he or she got screwed. And make no mistake, the buyer got screwed. At least according to the buyer -- the builder never returned my calls or emails.
So what is the real story? Why do builders insist that buyers use one of their "preferred" lenders? Why can't borrowers just go anywhere they want to and get a home loan without feeling as if they're being "forced" to take the builder's loan? I can't answer for all builders. Heck, I can only answer for one, for that matter.
A couple of years ago, a developer friend called me with a problem. He had finished building 48 homes in a brand new subdivision. All were under contract, all were nearly complete, and all of them were falling out of escrow. Why? The buyers couldn't get the financing that was promised to them by the sales department for the builder.
I took a look at his problem, and saw not one but two major issues. The homes were nearly all sold as investment properties and they were all promised zero money down, low-qualification loans. Hardly something anyone could pass up. The problem was that what they were promised -- in their contract -- was simply not available. At least so they thought. The whole subdivision was going down the tubes. And so was the developer.
Okay, let's not get into who's fault all this was or how many idiots it took to dream up this whole fiasco, but it happened. I agreed to finance these units for the builder, I found financing identical or similar to what was originally promised and everybody lived happily ever after. But that's not the story. The story is that the builder wanted to know the status of his closings. That was worth a lot of money to him. By knowing who the lender was on each and every deal, he would feel confident in getting a straight response from the loan officer -- me.
When a builder or developer builds houses and sells them, they usually operate under a line of credit or a loan. If the builder wants $10,000,000 to build 100 houses then that builder will typically go borrow the money to do that. As the homes are sold, one by one, that money goes first towards material, supplies, and labor, but most importantly goes right back to the original lender holding the $10,000,000 note.
A builder doesn't make anything until the very end. The sooner that note is paid off, the less money he pays in interest on the outstanding balance.
After the note is paid off, whatever next comes in is pure profit. If a $200,000 home falls out of escrow, for whatever reason, that builder needs to sell, fast, another home to make up for the $200,000 he's lost.
Interest on these loans accrues daily. And if a deal falls out, that builder is forced to pay additional interest. It's critical for a builder to count on a closing. No surprises. That's the story. No surprises.
That's why some builders ask or otherwise incent buyers to use their financing company. For the control. If there's a problem with a loan, the builder will know about it. And either take steps to correct the problem or quickly find a new buyer.
Any loan officer who has ever worked in new construction can tell you how, each and every week, they would complete a form then fax it back to the builder informing the builder on the status of all the builder's closings.
Delayed or cancelled sales cost the builder money, and lots of it, further eating away at the profit handed down in the final phases of a project.
Builders can have as many reasons to require buyers to use a particular service provider as long as they're legal and fully disclosed. Some builders like to make more money on each transaction through loan fees and origination charges. Still others like to be able to know on a moment's notice how their closings are going. Or any combination thereof. Given a level playing field there's nothing wrong with any of those scenarios. You'd do the same if the shoe were on the other foot. Wouldn't you?
