In an all-too common scene, a new-construction home buyer signs a new home contract at the builder’s model home and the sales consultant advises you that there is a particular mortgage company and a particular title company that the builder encourages you to use. The buyer is told that if you will use that mortgage company then the builder will pay “points” which is a percentage of the base cost of your home or the builder will give you a fixed amount of money as a credit toward your closing costs or toward upgrades. Using the example of a $200,000 house, that could be up to or even greater than $4,000 or 2 “points”. In addition, the sales consultant explains that if you utilize a particular title company that the builder will pay for the title policy, so you have two incentives to use the builder’s recommended service providers. The reason given to you is two-fold. Buyers are commonly told that with hundreds or even thousands of new homes built by that builder each year within your market, the builder has better control of the loan and title process that by buyers working with a number of different mortgage companies and title companies. That CAN be true. The loan process actually can go more smoothly and can go more quickly since the builder has a data base of recent sales of the same plan in the same neighborhood that you are having a house build. That means the appraisal on your property can be really quick. Similarly, the builder would prefer to work with a particular title company though which the builder may process hundreds of title policies each month. The end result is that if you cooperate by utilizing the builder’s affiliates that the benefit to you could be as much as 2 or 3 points on a $200,000 home purchase. While those may be truthful statements, what the builder is NOT telling you is those “affiliates” are often 51% owned by the builder so the builder profits from the volume of business going through those entities. Is that dishonest? No, it just isn’t the whole truth. Do you get the same level of service as if you select your own Mortgage Company and Title Company? With title companies the answer is probably yes. The State of Texas sets title policy insurance rates so different title companies will charge the same price for title insurance for a $200,000 title policy. What may be different are the title company fees that are NOT set by the State of Texas. As a buyer you will pay an “Escrow” fee which can be called a number of things and the cost to you can vary considerably. Remember that the builder likely owns 51% of the title company so at the end of the year profits from the title policy and other fees goes to the builder. Why 51%? Because it allows the builder to set up the name of the mortgage company and the actual title work is done by one of several national title companies. There are buildings in Houston that has the names of over 20 title companies on the directory of the building and the actual title work for all those companies is done by the same national title company. So going with the builder’s title company is not necessarily a bad decision so long as the title company “junk” fees are not out of line with other title companies. Next we get to the mortgage side of the business which is different.
What a builder does not tell you about mortgage profitability
There are four sources of income from a mortgage lo the mortgage company originating your loan. The first (1) is the “origination point”. If your new home purchase is $200,000 and you are obtaining a $180,000 loan (10% down) then you will generally be asked to pay a $1,800 “origination point”. Many mortgage loan officers are commissioned sales people whose income to feed their families is based significantly on that one-point fee. That is one reason many mortgage loan officers do as much volume as possible, sometimes picking the easiest loan product for them to present to buyers. Certainly there are professional mortgage loan officers who perform more as loan counselors than salesmen so I do not want to disparage them. Getting back to the origination point, some mortgage loan offices will tell you that “everyone charges it” but that is simply not true. It is negotiable so if you ask, most lenders will increase the interest rate on a loan to offset the origination point not being charged. You are still paying the same fixed amount but it is included in the interest cost spread over the loan period. Another article explains “buying down” the interest rate on a loan from a “par” rate and how to calculate the break-even point so I will not go into that here.
The second (2) source of income to mortgage companies is “discretionary fees” which can more properly be called “junk” fees. The terms vary among lenders whether they are called a “processing fee”, an “underwriting fee”, a “lender fee” or some other name but the result is that there will be origination charges that are income to the mortgage company. Depending upon the mortgage company, those charges are also negotiable.
The third (3) income source is “overage” that may be split between the loan office and ant mortgage company. The term “overage” means the interest rate locked in for your loan is “over” the current market rate and the resulting differential allows the lender to sell your loan to an investor at a premium. The premium will vary as interest rates change. Here is where builders can be deceptive. You are assuming that if you use the mortgage company recommended by the builder that you will receive a competitive interest rate to what you could get from another lender. When it comes time to lock your loan (30 to 45 days before closing) some builders might add ¼ or more to the market “par” interest rate on a buyer’s loan. The burden is on the buyer to figure out by getting competitive interest quotes whether the builder is really recapturing whatever incentives that you THOUGHT you were getting by using the recommended mortgage company. Like title company affiliates, builders create mortgage companies that are 51 % owned by the builder and 49% owned by a mortgage company who is actually the one who does all the mortgage processing.
Let me give an example of how this works. Let’s suppose a builder offers a $2,000 incentive for a buyer to use the builder’s mortgage company. Whether that is a credit to closing costs or a $4 to $6,000 credit (2 to 3 points) toward upgrades on the house (which may be marked up 100% to 400%), either way the buyer thinks they are getting a credit for utilizing the builder’s mortgage company. If the builder adds as little as ¼% to the loan interest rate above the current market “par” rate when the buyer’s loan is locked in then the builder’s mortgage company can sell the loan to an investor for MORE than the $4,000 to $6,000 based upon the interest rate premium at the time the loan is locked. In return for the credit to the buyer the builder’s mortgage company could make far in excess of the alleged incentive.
The fourth (4) source of income to the mortgage company is “loan servicing”. An investor will pay extra to purchase a mortgage loan whereby the investor can hold your escrow funds and receive monthly payments from you because they get to use your money without paying you interest. Mortgage loans are sold to investors either with servicing included or “service released”. The servicing value of a mortgage loan is not currently required to be disclosed to consumers.
What the Builder doesn’t tell you about taxes
If you are buying a new-construction home you are almost always buying into a brand-new or very recently developed subdivision. We have a separate article on when to buy in the life cycle of subdivisions but for this topic I’ll only focus on the front-end of the cycle. When a developer creates a new subdivision there must be water, sewer, and other utilities in order to sell lots and then build houses. Either the developer can tie into existing facilities (such as existing city utilities or an existing utility district) or the developer must create facilities in order to sell lots to builders. Buyers need to be aware that at the front-end of the creation of a new utility district (commonly called municipal utility districts or "MUDS") that the early burden of supporting the district falls heavily on the early homeowners until more houses are sold and the utility district cost is spread over a greater and greater number of property owners. As more property owners share the initial cost of the utility district that drives the utility district tax burden on a particular property owner. For example, a brand new subdivision where the first few hundred may have an estimated utility district cost of 1.50 % per $100 valuation for the first year which translates to $3,000. That $3,000 tax is JUST for the utility district on top of the school district taxes and county taxes. Total property taxes in brand-new subdivisions can be a total of 3.5% to 4% as compared to properties located in more mature utility districts that have dropped over time below 1% per $100 valuation. Builders often don’t point out if there is a heavy municipal utility tax burden in the early years of a new subdivision. Why? It is because taxes can be 1% or much higher than in other competitive neighborhoods in more favorable tax districts.
Builders also do not say much about the TIMING of purchasing a home in a new subdivision. January 1st is an important date for property taxes. Depending upon when you close on a property and the percentage that the house was completed as of January 1st, a buyer can have a rude shock when escrow requirements are changed. For example, if a house is started in January and completed that same year then the tax rate for that year will be ONLY for the lot value. If the house is 50% complete on January 1st of the year you close on the property then the assessed valuation will be 50% of the completed value. The point is that it can be to a buyer’s benefit to time the completion and closing of a new-construction house.
This is the SHORT version of detail which we can discuss with you about buying a new-construction home. You can find more topics on our www.houstonbuyeragent.com website.