In today’s dynamic mortgage market every loan agent worth his or her salt is looking for new loan products to originate that are tied into the purchase money market. Key to being successful in the purchase market is being able to sell products that are feature and benefit driven rather than “price driven”. While price is important, features and benefits of a loan program will set an originator apart from the competition and build realtor and builder relationships that are more likely to last long-term.
Consumer “Construction to Permanent” (CTP) loans fit into this bucket and can help build an originators “book of business”. This business can be built around both realtor and builder referrals, which most loan originators are already cultivating in one way or another.
BEFORE YOU START ORIGINATING CONSTRUCTION TO PERMANENT LOANS
If you are a product of the (now demised) refi boom and you’re satisfied with “selling price”, then CTP lending may not be a good fit for you. This is definitely not a business of order-taking!
Successful selling of CTP lending products will be based on your expertise in construction lending, and your ability to effectively communicate the features and benefits of Construction-to-Permanent loans to consumers and builders.
The purpose of this article is to assist loan originators in better understanding CTP lending and to give you insight into “how” to originate these construction loans successfully and profitably without having to sell price.
CONSTRUCTION TO PERMANENT LENDING TODAY
There probably has never been a better time to get into CTP lending than today! Inventory levels have never been lower in almost every housing market in the US. The GSE’s and government agencies are all stepping up their game to provide better and more efficient versions of consumer CTP loans. The home builders are all very hard pressed to obtain construction financing since the financial crises. Rates are still low but everyone that can refinance has already done so – multiple times.
While CTP lending also can refer to two-time close transactions, for our purposes we are only referring to single-close construction to perm (SC CTP) loans because that is where most consumer interest lies, for many reasons. This is true whether talking about FHA, VA, USDA, Fannie Mae, Freddie Mac, or Jumbo Portfolio products.
CONSTRUCTION TO PERMANENT LOAN MECHANICS
A single-close construction to permanent loan combines the features of a construction loan and an amortizing loan ALL under one promissory note, one deed of trust (mortgage), and one set of loan disclosures. This contrasts with a traditional two time close transaction where the construction loan and the permanent “take-out” loan are two separate, distinct, legal, loan closing transactions. Therefore, it is the features of the SC CTP loan that a consumer is seeking. These features that are inherent in a SC CTP loan have wide ranging implications for the consumer, builder, and the lender.
TWO OPTIONS FOR SINGLE-CLOSE CONSTRUCTION TO PERMANENT LOANS
Not all Single close construction to perm loans are alike! There are two different basic options (or versions) of SC CTP loans. This is an important consideration for the consumer and the mortgage loan officer needs to clearly understand the difference when presenting your product offering:
Option # 1 is a “conversion loan” that simply converts from an interest-only on funds disbursed to a fully amortizing loan on a predetermined date that is referenced in the loan documents.
In this version, the consumer knows upfront at the closing, what the interest rate is during the construction period and also knows what the permanent amortizing interest rate is at the closing. Therefore the Borrower is not exposed to any interest rate risk during the construction period, which could be up to one year! In addition the Borrower does not have to close a second loan and incur the required closing costs.
Option # 2 is a “modified loan”, where the borrower knows the interest rate during the construction period and once the home is complete, 9-12 months after closing, the construction rate is “modified” to the current interest rate that becomes amortizing. This option can expose the borrower to the same extreme interest rate risks that are found in a two time close transaction.
The sole benefit of Option #2 is that the borrower can avoid having to close a second loan – incurring additional loan closing costs. Statistically, borrowers often refinance out of modified loans because the rate offered at completion may be higher than the current market rate, therefore defeating the purpose of a SC CTP loan.
The lesson to the MLO is to know what type of SC CTP that you are selling against, so that you can identify these issues for the borrower. Whomever has the smarter mousetrap is likely to get the deal!
BENEFITS OF CTP LOANS FOR THE BORROWER
Building a new home takes a lot of effort on the part of the borrower and is often a long term planning process. Putting this effort at risk by failing to manage interest rate risk can leave the borrower disappointed and in a difficult financial position. That’s not a client that is going to refer their friend or neighbor to you for a SC CTP loan.
This process is all about managing expectations and delivering a positive consumer experience. CTP lending is all built upon referrals!
The “conversion” SC CTP loan offers your borrowers many benefits that you’ll need to be point out for your clients. These benefits include the following:
- Borrower can manage the interest rate risk of the permanent loan – obtain the most competitive 30-year rate available at closing.
- Borrower only pays the loan closing costs one time – a significant savings!
- Borrower only needs to qualify once – a matter of extreme convenience.
BENEFITS OF CTP LOANS FOR THE BUILDER
The SC CTP loan offers the builder benefits as well. This applies to both custom home builders as well as tract home builders. Builders struggle to get construction lines of credit due to changing banking rules, such as risk based capital requirements and loans to one borrower limits.
- No “loans to one borrower” limit give unlimited ability to fund projects.
- No longer carry a construction loan on the balance sheet as an open liability.
- Builders can sell lots under a separate contract to improve cash flow.
By regulation, under 12 CFR 32, FDIC insured banks are required to limit the amount of outstanding loans to any single borrowing entity. This is referred to as the “Loans to One Borrower” limitation and is intended to insure the “safety and soundness” of an insured institution. Many builders are often caught up in this issue and is one of the reasons that builders and developers sometimes struggle to get adequate credit.
However, when a builder opts to put the construction financing in the consumer’s name, under a SC CTP loan transaction, there is no “Loans to One Borrower” limit if the loan is being sold in the secondary mortgage market. The builder, in effect, has an unlimited ability to fund their projects.
The builder no longer has to carry a construction loan on the balance sheet as an open liability because the loan to build is in the consumer’s name. The construction contract is recorded on the builder’s books as a receivable asset.
If the builder is a tract home builder that also developed the lot that is being sold to the consumer for the given transaction, then the builder likely has an underlying development loan with a blanket Deed of Trust or mortgage that encumbers the subject lot. In order to release the subject property lot from the master deed of trust, the development lender will require a predetermined release price, so that the new deed of trust for a construction loan to the builder can be recorded in a 1st lien position.
That means, there are no proceeds from the lot release that actually go to the builder when the builder is getting the construction loan; this only comes when the house is complete and the sale to the consumer is made under a purchase money contract.
This is not the case when the construction loan is put into the consumer’s name. When financed by the consumer, the builder can sell the lot under a separate contract for a price that may far exceed the lot release price to the development lender.
The builder can realize a portion of their future profit when the consumer closes the SC CTP loan rather than when the house is finished – a big cash flow benefit to the builder!
How to Successfully Originate Construction to Permanent Loans
1. SELL CTP LOAN FEATURES
As described above, this will set you apart as a construction lending expert and give the customer confidence in your ability to help them.
2. SET CLEAR BORROWER/ BUILDER EXPECTATIONS
There is more review and due diligence work that has to be performed on a construction loan transaction! The Builder and project must be reviewed for completeness and numerous risk factors, there is additional construction related documentation (think contract, budget, etc.) that have to be reviewed and approved by the Lender. If you set the right expectations about processing timeframes, you will have happier customers.
3. EXPLAIN CONSTRUCTION RELATED FEES THAT ARE PAID BY THE BORROWER
Construction projects require review fees, inspections fees, loan administration fees, and additional title update fees. These are all necessary parts of the loan transaction, and if the Borrower understands that from the beginning, there will be no last minute surprises.
4. REVIEW CONSTRUCTION DOC PACKAGE
This is something you as the MLO can do to help ensure a successful closing. Have you gathered ALL of the required documentation that your construction program specifies? Have you checked to make sure that documents are signed and dated? etc.
5. BE PREPARED TO ANSWER COMMON CONSTRUCTION QUESTIONS
Do I pay any principal or interest during construction? What if I have a disagreement with my contractor? How can I stay up to date on the progress of work? Why does my builder have to be reviewed by the lender? Clear, confident answers to questions will put the customer’s worries to rest.
NEXT STEPS FOR ORIGINATING CTP LOANS
For the originating lender, a SC CTP loan transaction adds another purchase loan product to their offering. The SC CTP loan is a saleable loan into the secondary mortgage market, therefore the lender does not have to be a depository institution. If the lender is a depository, like a bank, the bank is not required to have the asset liability match needed to portfolio a loan – it can be sold in the secondary mortgage market and free up a lot of liquidity.
So, for you mortgage loan originators that can sell features, convenience, risk management, and consumer savings, this is a great lending opportunity for you. All it takes is a little patience, research and analysis, and a clear understanding of the benefits of a single close construction to perm loan transaction.