Construction loans are complex, yet hold the key to a limited, but loyal market.
Since many choose to build their dream domiciles to get just what they want-truly unique homes-it’s fitting that credit unions’ construction loan programs are also highly individual.
Most credit unions make construction loans to attain two intertwined goals: get members’ mortgage business and build a long-term relationship. Construction lending is not typically a highvolume business but is a high-touch service members appreciate. As programs featured in this article demonstrate, credit unions go about offering this valued service in very different ways in terms of pricing and process.
For example, $191 million, 43,000-member Air Academy Federal Credit Union, Colorado Springs, Colo., began making occasional construction loans in 1994, but “got serious two years ago,” says President/ CEO Glenn Strebe. Construction loans accounted for about 15 percent of total home loans last year or $12 million of $83 million in total volume. “If you are going to be good at mortgage lending, which we consider a core competency, you need to be able to offer the whole gamut,” Strebe says.
Another motive behind Air Academy FCU’s increased focus on construction lending is that the market encompasses members with high assets and credit scores.
For those reasons, the credit union prices its construction loans at prime rate. Strebe notes the short-term loans (usually six to eight months) to members with excellent credit ratings represent low credit- and interest-rate risks.
The major drawback is that making construction loans is time-intensive and requires specialized expertise. The credit union must either have experienced loan officers on staff or hire inspectors familiar with local building codes and the construction process.
When Air Academy FCU started making construction loans, it worked with an outside firm and later hired an experienced loan officer with a construction lending background. As a value-added service, the officer may look over floor plans and blueprints and offer such suggestions as “Well, you can get your sofa through the 36– inch front door, but will it go through this interior 30-inch doorway?”
“That’s a big plus, especially for those building for the first time,” Strebe says. “They say, `This is our dream home.’ We’d like to see them make as few mistakes as possible.”
The construction loan specialist has also developed relationships with established area builders, known as Air Academy FCU’s “Prime Partners.” Additional member benefits include the option to lock in a mortgage rate when members apply for a construction loan through the credit union’s One-Time Close program. That option simplifies the construction– loan-to-mortgage process down to five steps:
When members apply for a construction loan, the credit union hires an appraiser to set a value on the property and planned improvements. The credit union completes its standard financial and credit data review. The loan committee approves the construction loan.
Construction proceeds, with periodic inspections by the credit union, and draws are approved. The appraisal is updated when construction is completed, title work ordered, and the loan converted into a longterm mortgage. “It’s almost like simple housekeeping at this stage,” Strebe says.
The One-Time Close is only offered “when it’s the type of loan we’d want in our portfolio,” he adds.
SAME GOALS, DIFFERENT PRICE
AEDC Federal Credit Union, Tullahome, Tenn., began making construction loans in the late 1980s in response to member demands for the service and currently does 20 to 25 loans a year.
“We take a conservative approach,” explains Linda Weaver, VP/operations for the $700 million/105,000-member credit union. “We make loans only to members on their primary residences and require members work with a reputable, licensed contractor and not do any of the work themselves.”
AEDC FCU will finance up to 90 percent of the project’s appraised value and holds back 10 percent of principal until the project is completed.
Members receive a six-month lock on a mortgage rate when they apply for a construction loan, issued at the same rate as the mortgage members select. Though AEDC FCU makes mortgage loans to members nationwide, it only makes construction loans for homes in Tennessee and northern Alabama.
Like AEDC FCU, many institutions make loans only to “lock-and-key” projects in which contractors handle all construction. That requirement has created a lucrative niche for organizations like Bell Com Credit Union, Grand Rapids, Mich., which makes owner/builder construction loans for members serving as their own contractors.
Bell Com CU got into the construction loan business in 1987 when it partnered with Construction Loan Management, a private firm founded by Carl Heldmann, who literally wrote the book for owner/builders (“Be Your Own House Contractor” at www. byob.com). The credit union handles the financial end, while Construction Loan Management analyzes building plans and cost estimates to ensure they are realistic and conducts the necessary periodic building inspections to approve draws, explains Marilyn Nawara, VP/lending for the $142 million/27,000-member credit union.
Bell Com CU has built a $14 million construction loan portfolio, making owner/builder loans at 10.99 percent, or 1 percent over its rate for standard construction loans. Along the way it’s acquired some unique relationships, through Construction Loan Management, with big mortgage companies and banks, which send borrowers to the credit union for owner/builder loans-and then expect them back for their mortgages.
Thus, owner/builder loans are the end, not means to a mortgage, for Bell Com CU, which is content with the short-term revenue and opportunity to market other products to new members who join as owner/ builders. “Once they become members, they often take other products, like checking and deposit accounts,” Nawara says. “We try very hard to market to these members.”
Of course, there’s a reason why other lenders avoid owner/builder loans. Though Bell Com CU has had good experience, Nawara warns they’re extremely time intensive. Plus, owner/ builders “have a tendency to go over budget more often than contractors.”
Toward that end, Bell Com CU requires its owner/builder members build a 10 percent contingency cushion into cost estimates, and the credit union depends on Construction Loan Management to assess budgets and review sworn statements of costs during construction. When members start to run over budget, it’s Nawara’s job to meet with them and try to get them on track.
Even with Construction Loan Management handling site inspections, Nawara’s office keeps busy generating monthly bills for interest payments, which rise with each draw. She recommends any credit union considering owner/builder loans make sure their collections department is staffed to follow through on those bills.
“We have a low delinquency rate, but we make a real effort to stay on top of these interest payments,” she says. Occasionally, owner/builders run into serious problems-sometimes needing to sell the house to pay off a loan. “When things start to go bad, the best we can do is to get them to finish the house,” she adds.
Even when projects proceed fairly smoothly, owner/builders tend to take longer than contractors to complete the homes they’re building, typically spending about a year compared to the contractors’ average of six to eight months.
Bell Corn CU doesn’t do one-time close loans. It sets up the loan as a 12– month loan with a balloon payment at the end. It makes an end loan commitment to members who haven’t already committed to a mortgage with another lender but requalifies them financially before making the long-term loan.
GETTING THE WORD OUT
Early in the lending process, credit unions need to be certain construction loans they are making are suitable either to be held in their portfolio or sold in the secondary market.
Air Academy FCU holds most of the mortgages that result from construction loans in its portfolio, while Bell Com CU tends to sell off most of its mortgages. “But we do hold onto the creme of the crop-15-year fixed rate mortgages with high down payments,” Nawara says.
Word of mouth and developing relationships with Realtors and contractors are effective ways to market construction loans. Ira Oskowsky, president of The Credit Union Mortgage Alliance Network (CUMAnet) Bedminster, N.J., notes contractors are especially likely to recommend credit union financing to clients if they’ve had positive experiences. “Builders watch financing closely-they want to be sure they’re paid.”
Marketing for construction loans is less about mass media and more about word of mouth and seeking referrals from area real estate agents and builders, Strebe agrees. One payoff of building relationships is a steady stream of typically higher-end loans. Unlike the mortgage market, which fluctuates closely with rates, demand for construction loans is more steady, because people building dream homes are less driven by interest rates, he suggests.
Bell Com CU also gains most construction loan business via referrals. It also hosts an annual workshop led by Heldmann for builder/owners. This year’s workshop drew 125 participants.
Despite occasional problems, building that dream home is “a positive experience” for most members, Nawara adds. “We’re working with 142 people building homes now. It’s a great program, but it takes a lot of work.”
Karen Bankston operates Precision Prose out of her own Stoughton, Wis., “dream home,” a 94-year– old Victorian perpetual improvement project.
Copyright Credit Union Executives Society Jul 2001
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