Home Business & Finance Financing your condo, co-op, or townhouse
BUYING FROM A DEVELOPER
The developer is the entity that started the entire condo project
in the first place, from the ground up. The developer makes the plans, constructs the complex, hires a sales staff, handles the legal work around the CC&Rs, and takes on whatever else is necessary to facilitate the legal transfer of the properties to new owners.
Why do some developers build condos and townhouses while others build houses? Some of it has to do with individual areas of expertise. But if s also a matter of how and when developers get paid.
A builder of houses will get a contract on a home. After it's built, the buyer moves in and the builder moves on to the next home. But with condominiums and townhouses, the entire complex must be built before anyone can move in.
Buying from developers may also mean that you're required to use (or at least consult) some of their business affiliates such as lenders or title companies.
This is where you need to be on your toes. Developers can include language in the sales contract that says you must apply for a mortgage with a particular mortgage company. They can't force you to actually use their mortgage company, but they can insist that you at least apply.
There are business entities called controlled business affiliations (CBAs) and affiliated business arrangements (ABAs) that are created between various parties to work together and profit from a new development.
For example, the developer might have an ABA with a title company and a mortgage broker. This fact isn't hidden: When an ABA or a CBA exists, the salesperson you're buying the property from is required by federal statute to provide you with a disclosure that states, in essence, “Joe Developer and A Mortgage Company are partners and share the profits of this mortgage company.”
There can be several reasons to form such alliances, but the bottom line is to have the ability to share in the profits of affiliated services. There's no harm in that. In fact, an ABA or a CBA has to be set up if the developer wants a piece of the mortgage and title insurance pie.
But why can't the mortgage company simply give the developers a referral fee each time a buyer closes a loan with them? Because referral fees between third parties are illegal. The Real Estate Settlement Procedures Act, or RE SPA, requires that all monies changing hands from one party to another be disclosed to all parties, including the buyer and the seller. So, if someone sends a $1,000 referral fee that's not disclosed to all parties, he's in violation of federal law and can be fined, have his license taken away, or both.
One benefit of RE SPA is that it prevents “steering” a buyer to a particular third party, say an inspection company, when the buyer thinks the agent is doing her a favor, but the agent is in fact receiving a silent referral fee (aka a kickback) for making the referral.
In such a case, is the referral tainted? Of course it is. You don't know whether the agent is referring an inspector who will work in the best interests of the buyer or is simply making some extra money on the side.
There is nothing inherently wrong with a CBA or an ABA.
But you do need to be on your guard in a big way. When buying directly from a developer, be sure your agent carefully reviews the contract so you'll be aware of these relationships.
A developer can sweeten the deal by providing certain incentives for you to use his or her mortgage operation to finance your condo. How sweet? Here's a common incentive from a developer.
“Get a mortgage loan from our company, and we'll pay for your title insurance policy!”
Depending on where you live and how large your loan, that title insurance policy could run you $3,000. We'll discuss title insurance costs in chapter 6. Still, $3,000 is hardly something to sneeze at. Why not use the builder's mortgage company if you can save $3,000?
Who do you think will ultimately pay that $3,000? Did the developer factor it into the sale price of the unit? Or do you think he's just a nice guy with a penchant for making less money on every transaction?
When you go to the closing you may notice the mortgage company's rates and fees are higher than everyone else's — about $3,000 higher. Do you think the mortgage company is going to work for free? Loan officers have to get paid. And of course there's plenty of overhead, as there is for every business.
I don't think the developer wants to give you $3,000. And I doubt the mortgage company wants to, either. These are businesses. And like all businesses, they're around to make money, not to give it away. That $3,000 can be accounted for either in the price of your property (which certainly could have been factored in from the very beginning) or in the price of your mortgage. That means it's you who pay the $3,000.
Are all such arrangements set up this way, where the incentive is built into the price of the property or you get charged more by the lender? No, they're not. In fact, many such ABAs offer discounted products and services as a part of the ABA — and that discount can be passed on to the buyers.
So how do you protect yourself from being taken advantage of? You need to make certain that the developer's mortgage company is offering competitive mortgage rates compared to other mortgage companies in the area. We'll discuss this tactic in more detail in chapter 3.
When buying from an individual and not a developer, there'll be no incentives to use other third-party services such as inspectors, appraisers, or mortgage companies. The seller might say something like, “If you need a good inspector call this guy,” but really that's about it. It won't be something like, “If you use my mortgage company I'll pay you $3,000.”
Another thing to watch out for when buying from a developer involves how the contract is worded when it comes to getting the loan approved. At some point in the negotiation process, sellers will want to see an approval letter from a lender to let them know you're serious about buying.
Sometimes, however, the language in the contract can put you between a rock and a hard place when it comes to your mortgage. For instance, say a new condo is being built. The sales office will write up sales contracts and the buyers will wait to move in until the condos are finished. The mortgage loan doesn't close until after all the units are completed, sometimes months after you've signed the sales contract. In this instance, you sign the contract, put down some earnest money as a deposit, apply for your mortgage, and wait.
Recall the incentive to apply for a mortgage at the developer's mortgage company. Sometimes the contract can read, “You agree that if you cannot obtain financing from other sources and our mortgage company issues an approval, you will accept financing from our mortgage company. If not, you will lose your earnest money deposit.”
At first glance, that sounds fair enough. You can go anywhere you want to get financing. Why wouldn't you get an approval? And even if you didn't, why would one mortgage company approve when no one else approves your application?
I once received an e-mail from a buyer who was sorry that he had signed such a contract. He agreed to the wording that said if the developer's mortgage company got him an approval he would take the approval or forfeit his deposit money.
In this case, he did lose his deposit money, some $25,000 worth.
The buyer applied for the mortgage from the developer and at the same time got approved at his own bank. Now that he had his approval, he wouldn't need to worry about losing his deposit. Or would he?
As the condos were being built, he was also selling his own home. In fact, some of the funds to close would be coming from the sale of his property. In addition, his income was such that he could not afford both mortgages, so he had to sell his current home regardless of any down payment issues.
But his house didn't sell. He had it listed, but there were either no offers or the offers were too low. His bank's approval was contingent on his selling his current home.
The condos were days away from being finished. There was no way he could sell his house in time. So he asked for a letter from his bank saying he was no longer approved due to carrying two mortgages. He took the letter to the developer's mortgage company in the hope it would cancel his contract and return his deposit. The mortgage company said he couldn't have his money back because it had gotten his loan approved. He could either accept the approval or lose his money.
The buyer wanted to know how he got approved with such high debt-to-income numbers. The loan officer at the mortgage company said the approval was based on a no documentation loan. A no documentation loan means a loan where no income, no employment, and no debts are entered on the application. Debt figures aren't calculated whatsoever. Voila! Loan approval.
There was a catch: Mortgage rates on such loans are stratospheric, sometimes 2 or 3 percent higher than current mortgage rates. The higher rates help offset the risk of no documentation.
“But I can't afford two mortgages, much less another one with a higher rate!” claimed the buyer. And he was right. He couldn't afford the payments.
“Sorry,” said the loan officer. “The contract doesn't say whether or not you can afford the mortgage. It says you must take our approved loan or lose your $25,000.”
This actually happened. I don't recall exactly how he ended up, but I believe he sold his home for much less than the original asking price and took the original mortgage from his bank. It should be noted that not all contracts are written in such fashion. In fact, I hadn't seen one like that before. But the bottom line is that you (and your agent) must read the contract very carefully.
If you were still waffling on whether to use an agent to help you find a property and negotiate your contract, this should settle the matter.
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