As originally seen in Independent Banker.
Community bankers have historically considered construction loans an essential part of their loan portfolio. It’s a great way to support their communities’ lending needs and provides great earning assets for the bank. With the passage of the Dodd-Frank Act and the coming of the CFPB and its revisions to Truth in Lending, TRID, construction loans to consumers became “covered transactions” that require consumer Disclosures. Specifically, the Loan Estimate and the Closing Disclosure. Due to this new Disclosure requirement, many community banks dropped consumer construction loans. However, we now enjoy more transparency from the CFPB regarding the correct way for these disclosures to be issued.
The severe lack of housing inventory, aging housing stock, high consumer demand, and historic low interest rates have pushed new construction to new heights. According to the National Association of Realtors, the number of units available for sale in the U.S. fell to just over a million, which is less than a three-month supply of homes on the market. The last time the supply of homes was this low was during the historic conditions of World War II.
The low supply and high demand create an opportunity for community banks to offer construction loans to builders and consumers while fulfilling a need in their communities, and the CFPB has made it even easier by offering more transparency over the correct way for disclosures to be issued.
Grow Your Deposit and Borrower Base
Community banks that offer Construction Loans benefit by adding earning assets on the books that grow interest income. In addition, the bank will have enhanced capability to cross-sell products and services such as checking, savings (DDA’s), retirement accounts, IRA, wealth management, business loans, payroll, etc.
If the bank also makes mortgage loans, then construction lending, particularly single-close CTP loans, is a great compliment to a more purchase-centric marketing approach as refinances subside to rising rates.
Think Outside New Home Construction
It’s not only new home construction that can help grow your customer base, but commercial lending can be positively impactful as well. Many SBA 7A loans include vertical construction loans. Even SBA 504 loans can have an element of new construction for tenant improvements.
The benefits of SBA lending is widely known and appreciated in the community banking world. SBA loans offer government guarantees to businesses that might not otherwise qualify for low-interest rate leveraged loans to new businesses. These borrowers, including contractors and small business owners, offer the opportunity to cross-sell other banking services and will come back to you with repeat business.
How to Maintain a Healthy Portfolio of Construction Loans
Everything that has to do with maintaining a healthy construction loan portfolio comes down to managing risk. The following points will help lenders to begin, or audit their risk management policies:
- Know “Best Practices” of construction lending upfront- if you’re don’t know or are unsure, ask industry experts like us here at Land Gorilla.
- Do not disburse construction funds for work that hasn’t been completed.
- Do not disburse funds for deposits unless they are scheduled and netted out of the next draw to stay in balance.
- Always maintain lien waiver and budget control.
- Disburse draws using a “line item” disbursement method. Do not over disburse funds relative to the progress of construction.
- Require all change orders to be reviewed and approved by the bank in advance.
- Require contingency reserves to be included in the LIP (Construction Loan Holdback)
- Interest billing needs to occur in a timely fashion or interest reserves held in the LIP.
- Understand “Lender Liability” issues- such as Breach of Contract and Breach of Fiduciary Responsibility.
- Don’t lose money!
Use Technology as Your Foundation and Backstop
Lastly, a word of warning: Do not use spreadsheets to manage budgets and disbursements- they are unreliable, error-prone, and disappear at very inconvenient times, and they simply won’t let you scale.
Community banks would benefit by adopting technology that is scalable and efficient, redundant, and maintained on the cloud. This will translate into a good user experience for builders, borrowers, and the bank. With a scalable software solution, draw disbursement personnel can easily handle a much larger workload without adding additional staff.
Use the suggestions in this article to start or expand your construction loan programs. For more information regarding best practices and technology to scale operations, contact Land Gorilla.