Renovation Loans: Rebuild America And Your Company's Business
Loan officers can obtain a competitive advantage through renovation programs, which are not more complicated than standard lending products.
By Sherri L. Eckles
Although the mortgage market is healthy overall, lenders continue to struggle with a decline in volume and narrower profit margins. Renovation lending programs offer relief in both of these arenas. More lenders are beginning to see the advantages of focusing on niche products in order to make up for lacking volume and fierce competition.
Loan officers can obtain a competitive edge by specializing in products that can increase revenue for their referral sources. As with all niche products, the value added to the borrower decreases pricing sensitivity. The average size of rehabilitation escrows is in excess of $25,000. The company can receive not only a larger margin, but a larger loan amount.
There are many different renovation program options available. The market certainly has no
shortage of home equity products and lines of credit for funding repairs. One area that continues to present opportunity is first lien purchase and refinance renovation products. The FHA 203(k) and Fannie Mae HomeStyle are two primary examples.
Why is there a market?
Americans spent over $165 billion on home improvements in 1998. Eighty-one percent of the
existing housing stock in the country is over 15 years old. As housing stock continues to age, home improvement spending is projected to increase an additional 35% by the year 2010. The need for lending products to finance this growth should continue to increase.
Studies have shown that homeowners typically spend 50 to 100% more on home improvements in the first two years of homeownership than subsequent two year intervals. Loan officers can do their borrowers a service by asking if they plan to complete any repairs or make any changes to the home in the next few years, and include the cost into the mortgage at the time of purchase.
How do you get started?
Step one: building a resource base.
It is important for lenders to have access to the parties necessary to help put together a work write-up in order to complete the after-improved appraisal. The quality of the key players you involve in the transaction will determine the quality of the borrower's experience.
Lenders can be aided by 203(k) consultants, who can help streamline the processing time on a 203(k) or HomeStyle loan because they are trained in the proper preparation of the architectural exhibits required to complete the rehabilitation. Using approved 203(k) consultants on 203(k) and HomeStyle loans is highly recommended, since they play a crucial role in obtaining the work write-up.
They can also complete inspections as the work is being completed for releases from the
rehabilitation escrow account. If you are unsure how to locate an approved 203(k) consultant in your area, check your local HUD HOC Web site for a complete list.
Plan reviewers are responsible for reviewing the architectural exhibits, property and scope of the work to determine that the project is both feasible and conforms to HUD guidelines. For the 203(k), borrowers are required to utilize the services of either an approved 203(k) consultant or plan reviewer.
Many borrowers will ask their lender to refer them to a contractor who has done previous 203(k) projects. The success of the project can be improved if the contractor is informed of the guidelines for 203(k) rehabilitation projects.
Contractors that are known to be thorough and cooperative can be a real asset. Lenders should screen potential contractors for the program by examining credit reports, capitalization, experience and licensing. It is important that the lender requires the borrower to obtain a signed contract with the contractor stating how much the work will cost, exactly what will be done and when, and that it includes a binding arbitration clause in the event of a disagreement between the parties.
Appraisers are an important resource to lenders. Having an accurate after-improved value is the cornerstone of the program. Appraisers can often offer valuable insight into improving the plan for repairs.
Step two: understanding the products
How do the 203(k) and HomeStyle work?
The FHA 203(k) and Fannie Mae HomeStyle are fully disbursed first mortgage loans which allow a borrower to purchase or refinance a property and finance the cost of renovation with one closing. It is not necessary to complete the repairs before insurance can be obtained.
There is no up-front mortgage insurance premium on a 203(k), just the 0.5% monthly factor. Private mortgage insurance is required on the Fannie Mae HomeStyle for all mortgages greater than 80% LTV.
The mortgage amount for these loans is based on the projected value of the property with the work completed, taking into account the cost of the work.
The funds to pay for repairs are held in escrow from the date of closing in an interest-bearing escrow account. The borrowers request the funds to pay for the work as it is completed.
For those lenders who do not wish to service the escrows, there is an active secondary market that will purchase these loans from direct endorsement lenders and sponsored correspondents, and help the originating lender administer the rehabilitation escrow disbursements and accounting.
Some wholesale lenders will allow you to designate them an authorized agent and completely handle all of the post-closing draw administration directly with the borrower.
The perception has always been that these loans are much more difficult to close than normal FHA or conventional mortgages. In reality, the only difference between a standard mortgage and a renovation loan is the collateral package.
The underwriter evaluates the collateral based on an appraisal prepared to reflect the value of the property after it has been improved. To accurately obtain such a value, the appraiser must be given a work write-up detailed enough to determine exactly what repairs are being completed that could affect the marketability of the property in any significant way and the quality of the materials being used.
Getting the work write-up is the most important step in this process and is the only major difference between a regular loan and a renovation loan.
Who can get a renovation mortgage?
Owner-occupants and HUD-approved non-profit agencies are eligible to borrow under the FHA 203(k) program.
The Fannie Mae HomeStyle program offers many different options. The HomeStyle Standard can be offered for owner-occupied, second home and investment properties.
The HomeStyle Community is available for owner-occupied properties only. The HomeStyle
Developer is available for those investors who wish to purchase the property and repair it for resale. It enables them to obtain an assumable conventional mortgage at an owner-occupied loan-to-value and interest rate based on the after-improved value of the property.
Less cash up front with financed costs
Borrowers opting for an FHA 203(k) loan must finance at least $5,000 in repairs. There is no minimum for the Fannie Mae HomeStyle.
In addition to the actual cost of repairs, the rehabilitation escrow must contain a contingency reserve to cover unforeseen costs. The contingency reserve is generally 10% of the actual cost of repairs, but an underwriter may opt for a higher percentage on a 203(k) if there are extensive repairs or if the house is very old. The contingency reserve must be 15% on a 203(k) if the utilities are off.
If the contingency reserve is not used throughout the renovation period, it can either be used for additional repairs or applied to the principal balance of the mortgage.
If the property is uninhabitable while repairs are being completed, the borrower can to finance up to six months' mortgage payments into either an FHA 203(k) or an owner-occupied HomeStyle Standard.
This is an enormous benefit because it prevents the borrower from having to pay multiple housing expenses during the rehab period.
Other soft costs, such as the approved 203(k) consultant fee, plan review fee, architectural or engineering fee, permits or other costs associated with the renovation can also be financed.
On the 203(k), lenders can charge a supplemental origination fee which can also be financed. This is additional income to the lender and is the greater of 1% of the total rehabilitation amount or $350.
Lenders use a maximum mortgage worksheet to calculate the loan amount including all of the allowable costs and fees to be financed.
Step three: marketing the programs
Once you have your support lined up, you can begin marketing the program. There are three key groups to which you can market:
- Realtors,
- contractors, and
- retail distributors/dealers.
Realtors. There are many ways to market renovation loans to Realtors. The most important thing to do is educate them about how the program works. Many Realtors are reluctant to recommend 203(k) and HomeStyle loans because they fear they will delay the closing. In most cases, these Realtors are reacting to previous bad experiences prior to the agencies streamlined the renovation products to make them more marketable.
Realtors can help to move their "less than perfect" listings by helping the borrower envision the property as it will be, instead of how it is. They can uses phrases like: "If you want to change the color of the carpet in the living room, you can just include that in your mortgage." And they can point out that the borrower can have new the kitchen cabinets, bathroom fixtures, appliances, add an extra room, put on a deck, etc.
Additionally, Realtors can improve their listing power by assuring the seller a quick sale by marketing the property as a "Create your own dream home."
Contractors. Contractors like the 203(k) program because the funds are escrowed, so they know they will always be paid. Additionally, they know that the contingency reserve allows extra security should any unforeseen items arise while the work is in process. Many lenders find that contractors cannot only help a transaction go more smoothly, but can also be an excellent source of referral business.
Often borrowers are limited in their repair potential based on available cash/credit. The 203(k) or HomeStyle gives them an additional source of financing to afford more repairs.
Retail distributors and dealers. Kitchen remodeling companies and other retail distributors and dealers often find it useful to recommend the 203(k) or HomeStyle to their customers. In many cases, the borrowers can qualify for more expensive products under the more favorable terms of a first mortgage.
The customer can also include additional repairs if they wish, instead of being limited to the
distributors' specific product offering. Because repairs are being financed into a first mortgage, the interest is tax deductible, which it might not be if financed by expensive retail installment loans.
Creative loan officers can find an enormous number of ways to market this product. There are few homes on the market that meet a buyer's exact requirements for space and aesthetics, or that don't require some major or minor repair. Borrowers can even finance new free-standing appliances if the after-improved value supports the expenditure.
More than 60% of home improvements are being financed by high-interest rate second mortgages, unsecured credit card debt, high-interest rate retail installment loans or savings.
Obviously, a first mortgage renovation loan would be a great alternative to the first three methods of payment. The largest benefit to the borrower is that interest on first mortgages is tax deductible. The other methods would most likely be at a higher rate of interest and may not provide a tax deduction.
The first mortgage renovation loan could also be a profitable alternative to liquidating savings. In many cases, the rate of return on investments could exceed the rate being paid on the mortgage.
Additionally, the interest paid would be tax deductible, providing an additional opportunity for margin in the borrower's favor. This would obviously vary depending upon the rate of return on the borrower's investments and the current interest rate environment, but is definitely something to consider when marketing a renovation program to a borrower.
There are many investors who will help you train your sales and operations staff to originate renovation loans. Some state agencies have also started offering state-specific renovation loan programs. The benefits for your company range from increased product menu, to increased margins and revenue.
Demand for renovation lending products is likely to continue to increase over the next several years. Lenders choosing to promote renovation lending as a strategic initiative should benefit from this growth and the opportunities for added profitability associated with these products.
Sherri Eckles is a renovation product training specialist for the wholesale division at M&T Mortgage Corp. in Clifton Park, N.Y. She can be reached at (800) 755-5851.
This article was previously published in the February 2001 Issue of Secondary Marketing Executive
