I am asked the following question least 100 times a year:
Question: Is it legal for a builder to offer something to the home buyer such as extra funds to use for closing costs, or extra upgrades to the subject property, but then take those extra things off the table IF the home buyer refuses to use the builder’s preferred lender?
Answer: Yes the above is legal.
First I’ll address why the above scenario is legal. Next we’ll cover how it’s done. Last I will teach you how to educate your home buyer clients so you can compete against the builder’s preferred lender.
The federal law that speaks to this issue is RESPA, the Real Estate Settlement and Procedures Act of 1974. All banks, lenders, mortgage brokers, real estate agents, builders, basically any person or entity that earns a fee on a federally related loan must follow the rules set forth in RESPA. RESPA is a massive federal law with many sections so we will not review the entire scope of RESPA in this article. Instead we’ll only focus on builders and their preferred lenders.
In the 1990s when Al Gore invented the Internet, regulators were asked by our industry for clarification of how companies could grow revenue by creating affiliated companies. Such as a real estate company owning a mortgage company, a title company owning an escrow company, a mortgage company owning an appraisal company, a builder owning a title company, an escrow, company, a lender, and so forth. The idea was to offer the consumer a one-stop-shop for all things related to real property transactions. Regulators understood consumers wanted everything under one umbrella because it appeared to be more efficient and having affiliated services at companies all across town would be more expensive for the consumer. One of the main hallmarks of RESPA is to keep settlement costs low to the consumer, so more people could afford to become homeowners. So a builder having partial or full interest in a mortgage company was and to some extent, still is seen as being “in the best interest of the consumer” while supporting the real estate industry’s desire for more profits. Affiliated business arrangements are legal and there are many rules involved in these including a mandatory disclosure form provided to the consumer.
Now back to the builder. The reason why the builder can offer concessions and then take those concessions away if the buyer chooses a different lender, is because it is seen as being in the consumer’s best interest to have the option to use an affiliated company. There is one important rule regarding builders and their affiliated mortgage companies: IF the home buyer decides to select a lender that is NOT affiliated with the builder, the builder CAN take away the concessions but the builder cannot charge more for the home. I’m assuming the home buyer has been given the affiliated business arrangement disclosure form, so the home buyer then becomes informed about the shared business interests of the lender and the builder. We have disclosure forms for a reason and if the consumer decides to ignore it, then the consumer doesn’t get to complain later when the consumer learns that he/she has possibly been overcharged.
HOME BUYERS READING THIS ARTICLE: STOP. Think about this for just a minute. A home builder or for that matter any corporation, is not going to give you those concessions (closing costs or extra fancy upgrades) out of the goodness of their ice cold heart. Instead, the corporation increases the price. And builders do this to, for a very good reason. Builders must compete with each other’s new construction plats and older, existing homes. To get you to emotionally connect with their product, they offer something. Example: 3 percent of the sales price for you to spend on closing costs.
So here’s how it’s done: The cost of the home has been raised by…how much would you guess? Is your guess 3%? Then you win the imaginary crown of excellence for the rest of the day. You are smart. But the builders are smarter. Here’s why: When that transaction closes, in the next few months, appraisers are going to use YOUR sold home as a future sales comparison in their appraisals. So the 3 percent higher sales prices not only support future sales, they support future sales at a value that is 3 percent higher than today’s sale. And the next future new construction sale is also 3 percent higher than yours. Builders love this because it helps sell more homes! Look! See the pretty lights! Graphs and charts showing increasing values!
Now appraisers are suppose to check to see if there were any sales concessions in closed comps. Some appraisers check the multiple listing service which may or may not have that field in their software. Some appraisers call the builder’s real estate agent to check on pricing concessions but there is no rule that requires that Realtor to return the appraiser’s calls. So sometimes the appraiser knows and sometimes he/she does not know about the slightly increased sales price.
LOAN ORIGINATORS:
1) LOs: You MUST educate your home buyer clients at the pre-approval stage, before the clients starts wandering around on their own and into a new construction plat. Tell them that the above will happen to them. And tell them why the builder does it. Explain to the home buyer that it may not be in their best interest to finance, over the life of the loan, their closing costs in the form of an increased purchase price. It might be better, if their chosen lending product allows, for them to select a lender credit and select a slightly higher interest rate. Run the math with them, so they can see what might be in their best interest. If the builder is offering fancy upgrades, do the math with them: is it in their best interest to finance the cost of the upgrade windows, or carpet, or appliances, and amortize that over 30 years at X percent interest rate? or is it better to pay less for the home and purchase these items at a later date, at a lower cost of acquisition?
2) Educate the client that the builder/seller does not have their best interests at heart. The seller/builder is trying to move units and has sales goals to meet and you are being offered a worm on a hook to bait you into emotionally committing to that unit.
3) Loan Originators: Educate your Realtors who have referred this awesome client to you! Let them know that you expect your Realtor referral partners to support you and in turn you support them. Another way for the Realtor to think about it is, if a Realtor referred a home buyer to you, that there’s an assumption of trust that you, the LO are not going to steer that home buyer to a different Realtor. Of course not. Because your Realtors would not only rip your face off, they’d eat you alive and hold a public funeral for your reputation, dance on your grave, and then piss on it, throw an empty bottle of Jack Daniels on it and set your already dead reputation on fire. So since we have that all cleared up now, explain to your Realtors that you expect them to not only honor the hard work you’ve put into pre-qualifying their client, but you also expect to help your client negotiate with a builder to keep the loan transaction with you.
Realtors shout from the rooftops that they have value: They know neighborhoods! They know how to market property! They know how to represent clients! They know how to negotiate! Okay great. So this is where you, loan originator, educate your Realtors that when it comes to builders and their preferred lenders, they have a chance to prove to the world how good they are at negotiating and representing their home buyer client’s best interests (By the way I would never buy or sell a home without a Realtor.)
REALTORS
Here is what you do to keep the transaction with your favorite LO: Make the offer for an amount MINUS whatever the builder is offering. So if the list price is $350,000 and the builder is offering 3% (10,500) but the buyer must use the builder’s preferred lender, then the offer will be $339,500. with the home buyer using the home buyer’s preferred lender. Realtors, if you’re going to answer your loan originator by saying, “well there’s multiple offers on this home and buy now or be priced out forever” then clearly you need to explain what the heck you are doing to earn your commission representing this home buyer. What negotiating is taking place if you’ll just roll over and let the builder win?
But the real education must be done by the loan originator before the home buyer wanders into a new construction plat, so the home buyer is armed with the math and comparison charts. Because it is not the Realtor’s job to advise and educate on matters relating to the loan. The Realtor will never go this far and it can be argued that it is unethical for Realtors to advise in areas beyond the Realtor’s expertise. So by default, the education and comparison math must be done by the LO in advance.
Logic wins over emotion. If home buyers are buying ONLY based on emotion, then that home buyer is very easy to deceive and close. Get them to sign on the line that is dotted—The builder, the Realtor representing the builder, and the builder’s lender must prioritize moving units. The home buyer’s best interests are much further down on the list of the builder’s priorities.
I hope this has helped readers understand how the new construction “builder’s special” game is played.
I hope I have offended all parties equally, because I do aim for fairness when I deconstruct these issues.
Maybe someday we can get the builders to stop advertising that the closing costs or upgrades are “free” because clearly….these things are not free, but have been built into the price of the home.
Questions or comments can be sent to me via email jillayne at ceforward dot com