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By Shannon Faries
Director of Strategic Relationships, Land Gorilla
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 NAR, 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 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. For consumer construction loans, the CFPB has provided more guidance for the proper loan disclosures.
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 other bank products and services. 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
Commercial lending can offer a positive impact 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
Maintaining a healthy construction loan portfolio comes down to managing risk. The following points will help banks create, or audit their risk management policies:
- 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 won’t allow you to scale.
Community Banks would benefit by adopting software that is scalable and efficient. This will translate into a good user experience for builders, borrowers, and the bank. 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.