Financial Nearsightedness

Years ago when the Consumer Financial Protection Bureau was created, we had some wacko thought that part of the job of the folks filling its ranks would be to . . . protect the consumer.  In some people’s view, this would mean that builders of new homes would no longer be able to dangle the carrot of “free” incentives if the buyer would finance the purchase through the builder’s in-house or preferred lender.  To those same people, it just made sense that the CFPB was created to even the playing field and make it so that the consumer got the very best deal available.  Well, we were wrong.

Builders ARE allowed to offer incentives for using their in-house and preferred lenders despite the fact that sort of goes against the idea that the consumer is getting the very best deal available. And for most consumers, all they see is the incentive, and this computes to less money coming out of their pocket at closing – and they’re right (sort of).  The purpose of today’s article is simple: demonstrate how much money REALLY IS coming out of their pocket as time goes by.  

The first example is a gentleman who is purchasing a new home for a price of $555,331.  He’s being required to put 10% down, or pay $55,533 out of his pocket at closing.  Enter the builder’s incentive of $5,000 to be credited against closing costs –who can argue with that?  In this particular case, he wants an interest-only loan, which means that he’s only going to pay interest for the first ten years of the loan – the principal doesn’t get touched if he doesn’t pay any extra in that 10-year period.  The in-house/preferred lender offered him a rate of 5.5%, which means that his monthly payment is going to be $2,290.74 –in one year, he’ll be paying $27,488.88; in ten years, at the end of the term, he will have paid $274,888.80.  We offered him a rate of 4.75% on the same type of loan, which means that his monthly payment is going to be $1,978.36 – in one year, he’ll be paying $23,740.32; in ten years, at the end of the term, he will have paid $237,403.20.  Yes, you’re doing the math correctly, ladies and gentlemen: for a $5,000 incentive at the front end, he’s going to pay $37,485.60 more over the term of the loan.  In one year alone, he’s paying $3,748.56, and in two years, that’s $7,497.12 (which is almost .5 times more than the $5,000 he “saved”)!  Believe it or not, he went with the in-house/preferred lender for the “free” $5,000.

Now let’s go with a slightly more subdued example. This woman is purchasing a home for $260,000 with a 5% down  payment –$13,000 –for a loan amount of $247,000.  The in-house/preferred lender offered a $3,000 incentive in exchange for a rate of 5.375% on a 30-year fixed mortgage.  This yields a monthly payment (principal & interest) of $1,376.96.  We offered a rate of 4.875% on the same loan type for a monthly payment (P&I) of $1,301.86.  So far, that’s not that big of a difference, right?  In one year, that’s a difference of $901.20 between the higher rate and our rate.  It will take 41 months (just under 3.5 years) of paying the higher rate to cover the $3,000 incentive.  In ten years, which is the average amount of time someone stays in a home, our rate would save her $9,012 – and yet she went with the builder’s in-house/preferred lender. 

In both of these cases, $5,000 and $3,000, respectively, are sizable chunks of money that could cause some immediate “pain” in having to part with them – no argument there.  However, if these borrowers stopped for a moment and looked a relatively short amount of time into the future, they would see that they would easily recoup that out-of-pocket money AND THEN SOME. Obviously enough to afford an eye exam.