Please build my home. I just don’t trust you with my money.
When building a new home, different states have different rules regarding your down payment. Here in the sunshine state of Florida, builders are obligated to give buyers the option of either having the builder just keep the deposit, or requiring the builder to place the funds into an escrow account. This sounds like a no-brainer, right? Put the money into an escrow account. I know what you are thinking. It is my money. Why do I want the builder to have it? This is the easiest no-brainer since the microwave. Why are you even wasting our time with this blog (well, let’s not go that far).
Actually, the decision is not as easy as you may think (hence the reason for the blog). First, you have to ask yourself how comfortable you are with your builder. Are they a financially secure company? For public companies, this is fairly easy information to find out. For private companies, it is most likely a bit more difficult. However, you need to decide if you are comfortable with your builder’s ability to perform. Second, does the builder construct a quality home? Are you comfortable that the home that is proposed to be delivered to you will meet your expectations and be in accordance with the builder obligations as represented to you and as stated under the contract. The reality is that if you do not answer yes to both of these questions, you should probably not be buying the contemplated home anyway.
Let’s move on and assume that the builder is financially rock solid and that they build a high quality home, as all builders should. Let’s now readdress the matter of the deposit. If you are so inclined to have these funds placed in escrow, you need to understand that you may very well incur certain costs by taking this action. For funds placed in escrow, the builder will typically have the ability to borrow against these funds and to charge you for the cost to borrow against these funds. Now, these builder rights will need to be stated in the contract to be valid, which every builder worth their nail gun will make sure that they have done. Depending on the size of your deposit, this could potentially cost you a couple of extra thousand dollars. And for what? If you have selected your builder properly, there should be no concerns about what you are buying. You may have just as well have allowed the builder to keep the deposit up front.
Let’s take a further look at the deposit. The amounts requested may vary from builder to bullder, but let’s assume that you are required to put down 10% on a home at the time of contract execution. Let’s assume your home costs $300,000, requiring a $30,000 deposit. You may choose to let the builder keep the deposit to avoid the risk of incurring borrowing costs on that money. However, there may be an opportunity to actually make some money if you are willing to give the builder a greater deposit. As with any business, builders will have a cost of capital. This cost of capital will often be greater than the marginal interest rate that you can earn by keeping your money in the bank. There may be times and there may be builders (I know there are some) that will give you a discount on the home purchase for additional cash you are willing to pay up front as an additional deposit on the home. For instance, let’s say you plan to pay 20% of the home purchase in cash at closing and finance the remainder. In our example, that will require an additional $30,000 at closing. Some buyers may be willing to pay 3%, 4% or even 5% on that additional $30,000 if you are willing to pay that as an additional deposit up front. Remember, you are reducing the builder’s borrowing costs by giving them more money sooner, rather than later. (Side note: More money is better than less money and sooner is better than later. I learned that in business school.) So, if it takes six months to build your home and a builder is willing to pay you 5%/annum on your additional deposit, you would receive a closing discount of $750 on your home due to your increased deposit. Not bad versus just letting the cash sit in a bank account until closing.
I understand that this goes against conservative thinking. However, remember that a home is an investment. That makes your builder part of that investment. If you are willing to invest wisely, you may be able to avoid unnecessary additional home purchase expenses and, in fact, may be able to actually reduce the final cost of your dream home.
Until next time…
Keep kicking the dirt!