What Should You Put On Your Mortgage?

Here’s a scenario builders are sometimes confronted with by move-up buyers with an abundance of cash from their current houses — buy the appliances and carpeting outright from the builder and pay for the rest of the house with a mortgage.

On the surface, the idea makes good sense. Appliances and carpeting don’t last, certainly not for 30 years. So why pay double, or maybe even triple, their actual cost with a home loan that goes on for well beyond their expected lives?

According to the National Association of Certified Home Inspectors (NACHI), your brand new refrigerator might make it for 13 years if you take good care of it, but your range might not see its 13th anniversary. Dishwashers usually last only nine years, NACHI reports; carpeting, for maybe 10 years; a heat pump, 10 to 15 years; and HVAC systems possibly 15 years at the outside.

If you plan to remain in your new house beyond, say, 13 to 15 years, you will be paying with interest for these key items long after they fail and you have to replace them. So, to some buyers, it seems like a good idea to remove these products from a long-term mortgage by paying cash for them to the builder and having him or her reduce the total cost of the house by that much.

Say, for example, that the house costs $250,000 and the appliances and carpeting run $10,000. You pay that $10,000 out of pocket (along with requisite down payment and closing costs) and mortgage the rest. So, in this example, if you put 20 percent down, the loan would be for $192,000.

Builders don’t much care how you buy their homes as long as they get sold. But lenders? Ah, well, therein lies the rub.

For one thing, according to Mat Ishbia, president of United Wholesale Mortgage in Troy, Mich., lenders want to underwrite a fully working home, one that stands as security for the mortgage. If you buy — and therefore own — some key pieces, such as the appliances, and run into financial trouble down the road, you can take the appliances with you when you have to vacate because you own them. But that leaves the lender with less than a move-in ready property that can be resold to someone else.

In other words, the collateral behind the mortgage — the house — is less than 100 percent.

Then there’s the appraisal. It’s darn near impossible for an appraiser to separate the value of such key items of habitability from the house’s total worth. Indeed, such an exercise is typically an exercise in futility because they don’t know how and don’t want to be forced into placing values on particular building products as opposed to the whole house itself.

Consequently, the house will appraise for its full value, and your down payment would be based on that amount. So, in the above example, your 20 percent down payment would still be $50,000, not $48,000 (20 percent of $250,000 less $10,000).

All is not lost, however. There’s a better way to accomplish the same goal, one that is much simpler for all concerned, says Ishbia and other mortgage professionals. Just increase your down payment by the amount you were willing to pay for the appliances and carpeting. “It’s done all the time,” the Michigan lender says.

So again, say the house costs $250,000. With 20 percent down, you’d be left to finance $200,000. If you increased your down payment by the $10,000 you wanted to pay outside of the loan for the appliances and carpeting, you’d finance $190,000 — $2,000 less than if you had bought the appliances and carpeting outright.

Paying for items outside of the sales contract used to be more common; however, there’s no real savings or benefits. I wrote about the concept way back in the early 1980s, more than three decades ago. Back then, a long gone executive with the National Association of Home Builders (NAHB) suggested that homebuyers apply some of the principals found in the more sophisticated world of commercial real estate financing to their own situations.

Paying for items outside of the sales contract used to be more common; however, there’s no real savings or benefits.Under his scheme, which he called “component financing,” lenders would make four mortgages — one covering the “box,” or the house itself, for 25 to 30 years; the second covering the “amenities,” or items which wear out, for 10 years; the third for the land for up to 40 years; and the last for ground improvements, such as sewer and underground wiring, for five years.

When the four loans were added together, the total monthly cost would be within a few dollars either way of a single, overall mortgage. But by segmenting the costs, the total debt could be reduced; first, at the end of the fifth year when the ground portion is paid off and again at the end of the 10th year when the amenities loan is satisfied.

The buyer could either pocket the savings or use the extra cash to pay off the other loans more quickly. The NAHB exec believed lenders would be willing to break with tradition in this way. But he was wrong and his idea never got off the ground.

By the way, all of the above is not the same as wanting to purchase your appliances from a local dealer and asking the builder to leave his appliances out of the sale. No builder worth his hammer and saw will do that.

For one thing, most, if not all, builders will not allow anyone to install anything in his house until closing and it’s not his anymore. If one does, he opens himself to liability if the installer is hurt while in the house.

Also, builders assume responsibility if something is scratched or dented, or if it just doesn’t work, for items installed by his subcontractors. But if your dealer is the installer, it’s your responsibility to get him to stand behind the product in question.
You can’t ask the builder to give you an appliance-empty house, either. Lenders simply won’t lend on a house that isn’t complete and habitable when it changes hands.