Construction financing is having a resurgence. Demand for new housing is now at levels not seen since World War II and the rewards and profits are great for lenders that plan and prepare for this unique loan offering.
Similar to the unique set of processes and requirements of construction lending, a lender’s construction credit facility also brings a unique set of terms and agreements. These credit lines are a critical piece of a lender’s liquidity to originate more construction loans and meet growing demand. To be profitable, lenders must fully understand the agreements, fees, and cost of funds which all can have a major impact on a lender’s gain on sale.
Land Gorilla has compiled a list of crucial questions a lender must ask warehouse banks when considering a construction line. These details should be fully understood in order to grow a profitable program and avoid unnecessary financial risk. We have also included a list below of warehouse banks that offer construction lines.
Question 1: Is the warehouse agreement based on the disbursed amount or commitment amount?
The answer to this question will have a direct impact on the number of loans a lender can originate. If it’s based on the “commitment amount (loan amount)”, you will be more limited in the total number of loans outstanding at any one time. An agreement based on the “disbursed amount” is calculated on the aggregate amount of disbursed funds. This assumes that loans will mature at different times because they were closed at different times and as old loans pay off, new loans are funded. The “disbursed amount” method allows the lender to leverage the warehouse line more effectively.
Question 2: Is there a fee or penalty for non-utilization?
A fee or penalty for non-utilization is not uncommon. If the agreement includes a charge for non-utilization, lenders need to plan for a continuous flow of new originations in order to avoid that fee.
Question 3: What is the cost of funds?
A simple fact: the warehouse line of credit interest rate should be lower than the interest rate during the construction period. A reasonable spread and general rule would be 2% plus range. Lenders should then be accounting for monthly positive interest spread throughout the construction period.
Warehouse banks may determine a lender’s interest rate based on different factors, such as the construction risk, lender experience, policies and procedures, as well as other non construction related business. Obviously warehouse banks will look at the lender’s net worth and therefore their ability to absorb a loss if ever incurred. Lenders should be prepared to show their commitment to construction lending and scaling their programs.
Question 4: Does the construction line have to be part of a sublimit?
Lenders need to understand if the warehouse bank offers separate construction lines or if they must be a sublimit to a larger line of credit. This issue may affect other credit lines that a lender may already have in place.
Question 5: What are the requirements for personal guarantees?
Warehouse banks generally require a personal guarantee from the owner(s) or board members. Make sure you ask and are aware of the specifics of those guarantees.
Question 6: Is there an upfront deposit required?
It’s not unusual for a warehouse bank to require the lender to front a deposit when opening the line. The bank could look to use these funds to deduct interest, hair-cut fees, wire fees, or financially cover any problems with the line.
Question 7: Does the warehouse bank require a haircut on construction loans?
Will the warehouse bank fund 100%, 99% 95% or a different amount on a construction loan? It’s important for lenders to understand the haircut and factor that into their financial planning for construction lending. The additional hair-cut fee will tie up some of the lender’s capital until the construction is complete and the loan pays off. Lenders should prepare for this.
These seven critical questions will help you to make informed decisions about construction lines. If you are looking for a warehouse bank, we have identified some lenders, below, who offer these types of lines.
Warehouse Banks Offering Construction Lines
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