Finding the right home mortgage loan provider is complicated enough, but when you buy a house from a builder who has an in-house lender, the complications multiply. The builder wants you to use his lender, and will offer significant inducements to do so. This puts many buyers in a quandary as they realize that the inducements must be weighed against the likelihood that the builder’s lender will overcharge them.

Offering inducements 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/her 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!

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 subprime 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 overcharged. 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 overcharge. For example, if the loan overcharge is $2,500, the builder might offer kitchen cabinets with a retail price of $3,000, but which cost the builder only $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 online lenders on the same day. I will have a detailed explanation of exactly how to do this in the version of this article I place on my Web site.

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 online lenders such as Amerisave, E-Loan or IndyMac.

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 late 2006, 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 overcharges. In such cases, 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.

The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.

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