With the changing market we are now experiencing, it is getting more competitive when dealing with potential borrowers. Since we all have the same basic products, and essentially all the loans are sold to the same investors, we can easily get caught in the “commodity trap” of dealing with only price.
One way to differentiate ourselves from the masses of other originators, is to have a niche that most either don’t understand or stay away from. By having a product that is more specialized you can move away from the issue of price, and focus on being a resource and expert to your customer.
I accomplish this differentiation and eliminate 95 percent of my competition by adding construction loans as another pillar of my business. Construction loans can be custom construction, which is usually a person building their own primary residence or vacation home, spec loans whereby a builder constructs a home with the main purpose of selling it right away for a profit, and commercial construction for industrial, office, retail, or condominiums. Here, I’m going to focus on the owner occupied SFR primary or vacation home.
There are generally two types of loans. There is a two-time close and a single-close. The two-time close was the traditional way most construction loans were originally completed. A borrower would go to a bank and get a short-term construction loan that was essentially a line of credit to build the home. As soon as the home was complete the owner had to do a “take-out” loan and pay off the construction lender. This is usually a more costly and paper intensive way to finance a home, because the borrower will provide financials and pay the fees and costs associated with getting the construction loan. When they do the take out a loan at project completion it is a regular refinance, meaning they will then have to provide more financials and pay all the fees again.
In a single-close loan the lender does a construction and take-out loan all in one package. The borrower provides the normal financials required for any type of loan (full doc or stated), the lender underwrites and approves the loan, the loan funds and the borrower starts construction. At the completion of the project the construction loan automatically rolls over to permanent financing at no additional cost or paperwork (except signing a new note) to the customer. It saves the client a lot of time and money.
Construction loans are typically “build and lock” or “lock and build.” Under the “build and lock,” the interest rate during construction will float with the market (prime or some other index). At completion, the borrower will then lock their final interest rate and product type at current market rates. Under “lock and build” the interest rate is locked during construction, and at the time of completion the loan rolls over to permanent financing at the same exact rate. For example, if a borrower chooses to do a “lock and build” using a 7/1 ARM, and the current rate is 6.5 percent, they will have this rate during construction, and then it will roll to the same 6.5 percent at the time of rollover for seven more years. It is essentially an eight and a half year loan, because under the product I use they have 18 months to build and then the 7/1 ARM kicks in.
One point to keep in mind is that a construction loan is much more labor intensive for the originator. My estimate is that it takes as much as three times more work as a typical purchase or refinance transaction. I can justify this added time because the average loan amounts are nearly twice as much as my average loan, I have a more sophisticated borrower which I find is much easier to work with and appreciate professionalism and experience, and it is a deviation from my normal duties breaking up some of the monotony we can sometimes experience after years in the same line of work.
What are the reasons for this added work? There are three levels of approvals needed on a construction loan. Borrower approval which is the customer’s ability to qualify for the loan (just like a purchase or refinance), there is contractor approval whereby the lender approves the contractor building the home, and there is project approval. Project approval is a review of the budget, construction contract signed between owner and builder, and the appraisal. The lender wants to make sure the budget costs submitted are in line with similar projects in the same area. They want to be sure there is enough money budgeted to finish the project. The last thing a lender wants is for a borrower to run out of money midway through a project, and then have to take over the project. In addition to the two extra levels of approval (contractor and project) there is the added time of educating the borrower. Since this type of loan is completely different from what most customers have experienced from past lending transactions, you will spend much more time upfront and throughout the processing period explaining how the loan and draws work.
One obvious way to market your ability to do construction financing is through contacting contractors and architects in your marketplace. As you drive around town, take note of homes being built and write down the names and numbers of the builder and architect on the project (they almost always have their signs up on the property). You can also promote your business by obtaining a list of people who have applied for building permits. The easiest way to do this is find a company that compiles these lists from the local governments and sells the list. Once you have this list, usually provided weekly, send a letter to the owner of the lot introducing yourself and your construction expertise.
In addition, you can get a list of recently sold vacant land from your local title company and send a letter to these people. Most will eventually be building something on their newly acquired land. You can also do some research to find out which Realtors specialize in selling land. Since so few lenders do land and construction lending, I have found most of these Realtors are very interested in talking when they find out they may have a source that can assist them in selling their lot listings. You could hold seminars on construction financing, a strategy that has worked well for several originators.
Still another way for generating business is communicating with other mortgage originators. Since most LOs don’t know how to do construction lending, get out there and network with other successful originators and let them know you can take care of those clients they can’t help. You’ll find most would rather refer their customer to someone they know rather than just telling them they can’t help. Finally, get involved with local builder organizations. In most areas there are trade groups that meet on a regular basis, and you can typically join as an affiliate member and get a lot of exposure this way.
Adding construction lending as a pillar to your business cannot only help grow your business, but also soften the impact of a shrinking market while automatically reducing your competition.
By David Jaffe