This piece originally appeared in the October 2022 edition of DS News magazine, online now.
If any business should be used to market swings, it’s mortgage lending. Mortgage rates, like the economy, are constantly changing, and the housing economy is either headed up or down. And yet, every time there’s a significant shift in the housing market, some in our industry act as if they were caught off guard—even if they saw it coming.
Such a scenario is unfolding right now. After a series of aggressive rate hikes by the Fed, the bulk of lenders that were experiencing a historic volume of mortgage refinancings are now having to pivot and restructure while still attempting to retain top producers.
Loan officers, too, have had to adjust from raking in applications during the refi boom to navigating lower loan volumes.
However, there are always lenders and mortgage professionals with the vision to plan ahead.
Right now, many successful lenders have already pivoted to a market that offers great profit potential—construction loans. Yet, while still a lucrative option, construction financing can pose risks if you don’t have the right resources in place.
At this point, you may be wondering, why construction loans, and why now? An enormous opportunity in construction lending awaits those
who are paying attention. The United States is experiencing a massive housing shortage, the likes of which we haven’t seen since World War II. Back then, home construction practically vanished during the war effort. But when GIs started returning home and forming households, millions of people needed a place to live—which spurred the largest housing boom in our nation’s history.
The same scenario may be unfolding once again. In fact, a study by nonprofit research group Up for Growth, comprised of affordable housing and industry groups, recently found the United States is short 3.8 million housing units. Compounding this trend is the fact that hundreds of thousands of housing units disappear every year because they no longer meet health and safety standards.
Meanwhile, millennials, who recently overtook baby boomers as the largest generation of adults, are now in their 30s—the prime age for buying a first home.
Another factor working in favor of construction loans is that they aren’t as impacted by higher rates. Most consumers who build custom homes do not make their decision to have construction begin in the same week. There’s a much longer planning process—in fact, they could be making payments on lots for many years while they get building plans ready. They have so much invested in planning and carrying costs that they are unlikely to pull the plug even if rates go up. There are other options for reducing their payments, too—such as increasing their down payment, opting for an adjustable-rate mortgage, or reducing the square footage.
Even better is the fact that construction loans are incredibly profitable. Lenders have been experiencing margin compression on purchase mortgages and refi loans. Construction loans, on the other hand, generally offer significantly higher profits. In fact, the USDA has a product out right now that is by far the lowest risk, most profitable construction loan product in the industry. With these construction to permanent projects, which can be securitized by Ginnie Mae, lenders have the potential to generate a very robust gain on sale.
So, what is holding some lenders and originators back? Perhaps they’ve had experience with construction lending and discovered a cumbersome process. One of the main reasons why is that most lenders that originate construction loans rely on Excel spreadsheets to manage the draw process. This is fine if you’re only doing a few construction loans a year. But if you are originating multiple construction loans monthly, it’s a complete nightmare—and it eats into those otherwise great profit margins.
As the former Chief Lending Officer of a major bank, I learned about these difficulties the hard way. Even today, most lenders that are new to construction lending are getting headaches from using spreadsheets to track disbursements of loan proceeds used for draws. This method is not only inaccurate and contributes to loans being over-disbursed, but spreadsheets are known to fail and crash as well. The bottom line is that spreadsheets are not an adequate system of record given the liability lenders have.
Turning Things Around
Despite the complexities and risks, lenders and mortgage professionals have a unique opportunity to take advantage of the profits construction loans afford.
Thankfully, technology is available that makes the process more seamless and efficient. The key is implementing a transparent, end-to-end platform that serves as the system of record for all construction loan programs. Such a platform can be used to manage and track all the processes involved in construction loans—inspections, lien waivers, draw requests, change orders, and more.
This type of innovation does two things: first, it removes the manual processes involved with managing construction loans that inevitably lead to profit leakage.
Second, it serves as risk management for any bank or mortgage company making construction loans, especially when a platform comes equipped with state-specific lending requirements. If there’s ever an issue involving approvals or disbursements, the platform can instantly report everything that took place during the process.
Today’s cloud-based technologies can maximize profits, reduce risks, and help streamline and simplify construction lending. It can make things safer and more convenient for borrowers, too.
This includes an app for borrowers and builders to submit requests and documents, view accurate budget information, and communicate with your team. A centralized system of information and communication will provide transparency, eliminate friction points, and deliver an exceptional experience.
Construction lending technologies can save money in other ways as well. For example, one of our clients reported an 80% decrease in emails from borrowers during the construction draw process after implementing our platform. That translates to a significant reduction in time that staff is dealing with back-and-forth communication, which can enable employees to focus on more value-added activities.
There are still other benefits. For instance, right now, there’s a premium in our industry for top producers. But if you’re a lender that does not have a robust selection of products that includes construction loans, you’re at a severe disadvantage when it comes to recruiting. On the other hand, lenders that do offer construction loans and have adopted technology that makes the process fast and hassle-free are much better positioned to attract a high-performing sales team.
At the end of the day, lenders are in this business to make money, but today’s market has made this more difficult to do so.
With substantial profits in construction lending, huge demand for new housing, and technologies available, construction lending represents one of the biggest opportunities for lenders and originators to turn their fortunes around. And there is no better time to capture this opportunity than right now.
Smart professionals are always looking at the road ahead. You can go back to the Great Recession to see that lenders that picked up their FHA designations to take advantage of first-time homebuyers jumped far ahead of the pack when the market began to recover. The same thing happened several years ago for lenders and loan officers who foresaw the historic, extended refi boom.
For lenders that offer construction to permanent loans but are wasting time and money wrestling with spreadsheets, now is the time to invest in sensible technology that eliminates these historical inefficiencies. The same goes for lenders who may be thinking about launching a construction loan program. With technology, it’s never too late to start maximizing profits today and certainly as the nation’s next building boom moves forward.