TheMReport — News and strategies for the evolving mortgage marketplace.
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32 | M R EP O RT FEATURE I f 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 aggres- sive 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. Brewing Demand A t this point, you may be wondering, why con- struction 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 thou- sands 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 invest- ed 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 lend- ers and originators back? Perhaps they've had experience with con- struction 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 con- struction loans a year. But if you are originating multiple construc- tion 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 contrib- utes 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. Curing the Low-Volume Blues Here's how construction loans can help offset market swings for lenders feeling the pinch. By Shannon Faries