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Build a Viable Construction Lending Program Through Construction Loans

10/23/2006

Is construction on the rise in your area? The answer is most likely yes, as the number of single-family building permits rose 14 percent between June 2003 and June 2004, according to the National Association of Home Builders.

Credit unions can enter this marketplace and provide financing for potential homeowners or small business owners who are planning to build on an existing lot. Construction loans are becoming an increasingly popular tool to both increase membership and loan originations.

"The credit union gets a higher loan balance, since new construction typically has a higher loan balance than purchases and refinanced mortgages," said Tom Baldwin, chief financial officer of Space Coast Credit Union ($1.2b) in Melbourne, Fla.

Members or member business owners who apply for construction loans are generally strong candidates with high credit ratings, a prerequisite considering the loans' typically high balances. While the average loan varies according to the geographic location, residential construction loans typically range from $175,000 to $350,000. Member business loans can be several times more expensive depending upon the size and scope of the business.

Though the benefits may be apparent, credit unions wanting to implement a construction lending program need to be aware of the types of loans offered and the value of partnering with an experienced provider.

Types of Construction Loans Credit unions have two options when considering construction loans. A one closing construction loan locks in a rate for both the construction and permanent mortgage periods. A two closing construction loan locks in a rate for the construction period, but the borrower must sign a new loan contract once construction is complete and the loan transfers to the permanent mortgage phase.

A benefit of one-closing loans is that members can modify the construction loan to any mortgage product the credit union offers. The credit union should advise the member throughout the process to ensure appropriate mortgage selection based on the member's specific needs and financial situation. A one closing loan will reduce operational costs by qualifying the borrower with one application for both loans.

While one closing construction loans are more cost efficient than two closing loans, they are inherently riskier. Credit unions are locked into a rate for both loan phases and are prone to interest rate risk. However, some credit unions are charging an additional 25-100 basis points over the current prevailing rate for the permanent mortgage to hedge against interest rate fluctuations. For example, University Federal Credit Union ($632m) in Austin, Tex., builds in a 25 basis point premium. However, the credit union will eliminate the premium if the rate does not increase during the construction period. The member receives the lowest rate in either scenario.

A two closing loan allows a borrower to close a construction financing loan consistent with the financing terms from a permanent mortgage. The process to qualify for the permanent mortgage is streamlined since the application documents from the construction loan can be re-used. Borrowers have the option to either continue the permanent mortgage with the same lender or seek a more competitive rate elsewhere. Credit unions can develop a close working relationship with the member during the construction period to deter the borrower from seeking other rates. Forming Business Partnerships If your credit union does not have the necessary staff to implement a construction lending program, there are still options. A credit union can partner with a full service mortgage and construction loan company that fulfills many if not all of the additional responsibilities.

For a credit union that does not have the necessary experience, partnering with an experienced lender can alleviate much of the stress associated with beginning a construction lending program. The level of involvement is determined by the credit union, and it can ask the partner company to take on the remaining roles. The credit union still retains the right of first funding and it can sell the completed construction loans to the secondary market.

For more information about construction lending, Callahan & Associates, Inc. recently released a Market Update: Building a Successful Construction Lending Program.

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