There are some major home builders offering substantially discounted interest rates along with the purchase of one of their homes – as long as buyers use the builder’s mortgage lender.
And many buyers think they are getting the deal of the century when they get this “special financing.”
But – here’s the thing: The financing is not “special” and there is no free lunch.
Large builders do NOT have access to cheap money or special loans that are not available to the rest of the world.
The Cost of Discounted Mortgage Rates
All builders can do is offer below-market interest rates through their mortgage arms, and then sell those loans at a steep discount/loss.
In other words, if a builder offers a permanent mortgage rate in the 4% range, it would have to sell that loan with as much as a 6% to 8% discount (or loss).
If a builder offers rates in the 3% range, the discount could be as much as 12%.
NOTE: Mortgage lenders make money by selling loans at a “premium” or for more than the amount of the promissory note. For example, a lender might sell a $100,000 loan for a 2% premium or for $102,000. If a lender sells a $100,000 loan with an 8% discount, it will sell that loan for $92,000 – and take a loss (unless the borrower paid for that discount up front).
In other words, if a buyer has a $500,000 loan, the builder is taking anywhere from $30,000 to $60,000 loss through its mortgage arm when it provides below-market financing.
So – in other other words, the buyer is effectively overpaying $30,000 to $60,000 for that home.
Why Overpaying for “Special Financing” Is Not Worth It
Buyers would be better off getting their own financing in most cases and instead asking for a reduction in price of $30,000 to $60,000.
Builders of course don’t like that approach because they want to keep their home prices inflated as much as possible – even if their “effective prices” (after absorbing the loss from the loan) are the same whether they offer discounted mortgage rates or discounted home prices.
Builders prefer the optics of the higher home prices – with the loan loss hidden somewhere else in the financials.
Here is what makes overpaying for a new build in exchange for a discounted mortgage rate even less appealing: the prospect of sharply dropping interest rates.
If rates fall another 1% to 2% this year, like many macro observers are predicting, those buyers who overpaid for their new builds to get their discounted mortgage rate will have wasted their money – as they will be able to refi into a lower rate anyway.
Don’t fall for the “special financing” trap. Builders are not offering anything that isn’t available elsewhere, and buyers often end up overpaying for their homes in the long run.
Founder | JVM Lending
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