Many people in business have probably heard that “the more lines you put in the water, the more likely you’re going to catch a fish.” The underlying lesson is particularly valuable today.
Last year, when the refinance market was steaming along, mortgage originators didn’t need to have many lines in the water. In fact, they only needed one — and even then, they were often catching more than their limit. In today’s market, however, it’s important to have as many lines in the water as possible.
It’s important to remember that with construction loans, originators have two clients — the borrower and the builder. The goal is to help both.
There are some good reasons why one of these lines should be for clients who wish to build a home. But construction loans are quite different than other mortgage products, which means if you’re going to use them to catch fish, you don’t want to leave shore unprepared.
Whether you’re familiar with construction loans or not, now is the time to give them a serious look — regardless of what you may be hearing about the new home market. You should be looking at all types of construction loans, too, from jumbos and nonqualified mortgages (non-QM) to loans with float-down rate options. The reason why is that the number of people who need construction financing could skyrocket in the not-too-distant future.
Of course, the homebuilding market is struggling at the moment. Recent builder surveys point to the fact that demand for new homes has softened, which is reflected in reports about declining construction permits and new home starts. There are even some tract builders who are selling homes at a discount to private equity firms due to fears that demand will continue to fall. Over the past couple of years, the home construction industry has been dealing with rising prices for commodities, supply chain issues and increased labor costs.
More recently, however, the industry is starting to see the tables turn. Commodity prices and labor costs have been trending down, and new home construction is starting to become more affordable. As the price per square foot for a newly built home approaches resale price levels, new homes will become much more appealing to consumers, especially to those who put their plans on hold during the COVID-19 pandemic and are now coming back into the market.
But there’s another (and potentially even bigger reason) why savvy originators are adding construction loans to their business. The U.S. needs more homes — a lot of them.
In 2021, the National Association of Realtors estimated that the U.S. had a shortage of at least 5.5 million new homes, a gap that has grown over the past two decades. It’s not uncommon to hear about low inventory in most housing markets, and there are simply not enough new homes being built to keep up with new household formations. This problem is being felt in virtually every market, large and small, across the country.
Many people understand that only increased home construction activities will bail the nation out of this situation. And yet many banks and mortgage companies are exiting the construction loan business due to current interest rate volatility. The good news is that this opens up opportunities for originators who plan ahead. With a solid construction lending partner, originators can leverage a wide variety of construction loans for multiple borrower scenarios and gain a significant competitive advantage.
Many large homebuilders, for example, will typically provide their clients with the initial construction loan, while the builder’s mortgage partners will provide the client with a permanent loan. With the right partner, it’s possible for originators to provide all of the financing for ground-up construction, which presents the opportunity to significantly expand their current portfolio of business.
Construction loans are somewhat of a niche product and not everyone understands them well. For the past 15 years, the market has been dominated by conventional and Federal Housing Administration (FHA) loans. During that time, originators were often able to do just fine without selling a single new home loan, especially during the extended refi boom of the past few years.
Because construction loans are different than mortgages for existing homes, a bit of education can go a long way. To get started or to expand the types of construction loans you can offer to borrowers, it’s best to align with a bank or private lender that has significant experience with them as well as a robust selection of options. Many companies say they offer construction loans, but few are committed to them.
It’s also important to know that large homebuilders usually make money by providing both homes and loans, and they will offer the consumer a deal if they use the builder’s lender. Usually, the builder is making up the difference somewhere, so it is something of a shell game. Originators should think of it this way when advising their clients.
Even homebuilders that offer their own financing do not have many options. In fact, the same is true for many lenders, which often leaves borrowers on the sidelines because they can’t qualify under fairly rigid agency loan guidelines. This is particularly true for a growing number of homebuyers who are self-employed or run their own businesses.
There are wholesale lenders that have many options. These choices will include single-close, construction-to-permanent financing, as well as products with float-down rates, jumbo construction loans, and construction loans for self-employed borrowers and investors.
Recently, in fact, new single-close non-QM construction loans have hit the market that allow self-employed borrowers and investors to finance a wide range of residential projects, from single-family homes to duplexes and even rental properties. (Non-QM mortgages are ineligible to be purchased by Fannie Mae and Freddie Mac.) With these products, the construction is financed at 0% interest and the borrower is able to lock in their permanent rate within two months of closing.
Being able to offer non-QM construction loans gives originators a chance to create relationships with tract builders that are having difficulties finding conventional buyers, which has become common in today’s high interest rate environment. Many homebuilders will be open to a discussion, but it’s up to originators to start these conversations. At a time when everyone is looking to generate more sales volume, this is time well spent.
The good news is that you don’t need special tools or a particular origination system to sell non-QM construction loans or any other type of construction loan, nor do you need to reinvent the wheel. But unless your company already offers these products, you will need a solid wholesale partner.
A good construction lender typically invests in its own technology, systems and staff to ensure that every construction loan transaction is smooth and hassle-free. Usually, they will have a solid scenario desk and be able to show you how to calculate costs. Some wholesale partners will even talk to a client or a builder to explain how the process works.
On that note, it’s important to remember that with construction loans, originators have two clients — the borrower and the builder. The goal is to help both, which is why every originator selling construction loans should be talking to every builder in their market about the products they offer. If the originator has access to a full line of construction loans — including non-QM, jumbo, FHA, U.S. Department of Veterans Affairs and U.S. Department of Agriculture products — these conversations are likely to lead to great business opportunities.
When you understand all the different construction loan products that are available, and if you have strong partnerships with wholesale lenders that have deep construction lending experience, you can speak with confidence to builders. You’ll then be in a great position to get referrals from them, especially when they encounter interested buyers who don’t qualify for traditional financing.
It’s important to remember that every time there’s a significant market shift, the mortgage lending landscape shifts, too. Some lenders inevitably do better than others while some don’t make it to the other side. In fact, some companies have already closed or downsized.
When the market declines, the smart thing to do is to look for opportunities among borrowers with unmet needs. One of the biggest unmet needs in today’s market is construction lending. Right now, shrewd originators are adapting to the new environment by putting more lines in the water. If construction loans are part of their strategy, they are setting themselves up to catch many more fish than expected. ●
Michael Isaacs is CEO of Go Mortgage. With a career spanning 25-plus years, Isaacs fulfilled his passion of owning a mortgage company again by purchasing Go Mortgage in November 2021. Prior to the acquisition, Isaacs was the regional vice president of sales for Fairway Independent Mortgage Corp. for five years. He previously served as president and CEO of Residential Finance Corp. (RFC). Under his watch, revenue at RFC increased by 68% in four years and it was named to the Inc. 5000 list of the nation’s fastest-growing private companies.
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