Here’s perhaps the top reason builders add on tons of “incentives” instead of lowering the price of new homes outright.

When builders lower the price, buyers who have already contracted to buy a new home tend to cancel their contracts.

It can be better, however, for the prospective buyer to cancel the contract and lose his earnest money rather than to proceed to buy a new home at a price that is higher than what the builder is currently charging for the same home.

New-home builders are taking a big hit from record numbers of contract cancellations, or “kickouts.” Fort Worth, Texas-based D.R. Horton Inc., the nation’s biggest developer, says its cancellation rate is currently 40 percent, compared with 29 percent a year ago. Meritage Homes Corp., in Scottsdale, Ariz., is reporting a 37 percent kickout rate, compared with 21 percent a year ago. And Standard Pacific Corp. says that 50 percent of its contracts fell through in the third quarter of this year, compared with 18 percent for the same period last year.

I sure wouldn’t want to put a lot of money down on a new home right now.

But as the market has cooled and kickout rates have risen, nervous builders have also been quietly sweetening the pot for buyers they have already snagged but whose contracts haven’t yet closed – just to keep them from bailing out of the deal. Some are even offering to drop the selling price after contracts have been signed.

When will cancelations ease up?

Ms. Cutts expects that buyers will regain their confidence by late spring, causing cancellations to ease up. Vienna, Va., housing economist Thomas Lawler agrees, but says builders must continue to cut their production and sell off their inventory so supply and demand can get back in balance. “Builders need to take a bullet,” he says.

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