These topics help a lender determine the best course of action to take their renovation lending desires from a basic program to an advanced platform built on efficiency and using proven business principals known for being best in class.
Below are some questions lenders should ask when determining the way they will establish a renovation lending platform. Unlike many loan programs, renovation lending is not just another “product” to roll out. It requires a commitment to developing a full platform offering these programs in the most beneficial and profitable manner. The following information goes beyond the “basic” level features and benefits to discuss the advanced concepts lenders need to consider with regard to draw management. This information is pertinent to companies considering the programs and to companies offering the programs today to determine the true profitability of their platform.
Execution Points for Draw Management
Perception of the renovation process by the borrower
Do your borrowers feel the process worked well for them after the loan closed? Do you even know for certain?
The project phase of a renovation loan is the last memory the borrower has of the overall loan process. If all the correct expectations were set prior to close and then followed during the project phase, the borrower will have a good perception of the process, be thrilled to be living in the home they envisioned at the outset, and be a source for strong referrals.
If their perception of the process was not a good one, it will limit one of the largest benefits of offering renovation loans, getting multiple strong referrals. This is a topic I have written about many times. It is vitally important for lenders to understand why renovation loan referrals are the strongest a loan officer or lender may ever receive and their importance in offering the program.
This is an area many lenders overlook in their renovation lending platforms. There is much concentration on the process and how the borrower perceives the process prior to closing, but many overlook the borrower’s experience after closing. This perception may be even more crucial than their experience prior to close.
Whether you are working with another party for draw administration or doing the process internally, do you know how the process was perceived by the borrower?
Quality renovation lenders will obtain feedback from borrower’s on completed projects to determine if the process that was sold to them is what they felt they received.
There are so many benefits obtaining the borrower’s feedback on the project phase, it is incredible so few employ this process. The perception of the borrower’s experience is extremely valuable information to collect. It shows how the draw process and staff delivered on what was originally sold. If there are inconsistencies, it allows lenders to determine if those are caused by poor execution of the sales staff, by the draw team, or both!
If lenders use an in-house system and don’t collect this information, they are ignoring this important piece of performance monitoring. Collecting this information is the only way to grade the efforts and ensure the origination side of the loan coincides with the service being performed on the back side of the loan. When done properly this process will deliver key information to further developing a company’s renovation lending platform.
If you are working with a third party for the draw process, do they collect and share this information? How is the performance of their staff and do the results measure up between the sales process and the draw process?
If your third party doesn’t employ this process, how do you quantify the results delivered to their lender clients?
The usefulness and benefit of this information is vitally important to a successful program. Lenders should request this information from the draw management department, regardless of who is providing the draw management service.
Without collecting and measuring this information, lenders have no way to determine the success quotient of the draw management process. There is no measurable way to confirm perceived success benchmarks without this information.
See the question, “Do they provide feedback on the process”, within the Investor Servicing section of this document to see the information that any draw administration area should be providing which allows a lender to quantify results of the renovation process.
Cost of management/resources
Have you considered the cost of managing the draw process for renovation projects and is it the best use of your resources?
If developing an internal draw administration service, lenders must consider the cost of the staff, the resources needed for training, and the delivery of a best in class service. This does not mean lenders should not or cannot develop their own service, but many overlook important factors and the importance of developing a professional draw administration service.
One of the key benefits of offering renovation loan programs is to develop more business, for both renovation and non-renovation production. Ignoring the quality of the service provided after the loan has closed on a renovation is a key mistake of lenders and one which may prevent delivery of the full benefit of the program.
Is your company getting multiple strong referrals from your renovation lending borrowers and network partners? If not, you should be!
There are many benefits to offering renovation lending. The most prevalent and basic benefits are building strong outside referral networks and borrower referral opportunities that do not exist on non-renovation lending programs. Renovation lending provides tremendous opportunities to gain entry to Realtor, Contractor, Architect, Engineering, and other firms related to the remodeling industry, as well as providing some of the strongest borrower referrals of any lending program offered.
All these referral opportunities will be contingent upon the project being successfully completed. The entire pre-close origination and process may be executed with surgical precision, but if the project goes off the rails post close, all the successful efforts pre-close will be for naught. This is why lenders need to ensure a successful completion of the project. That is the most important requirement to receiving the numerous and strong referrals the programs offer.
If the project phase is a failure, then referral partners are not happy nor are borrowers supplying strong referrals, meaning the work of rolling out the renovation programs for lenders is a waste of time and resources.
[The reference below to draw administration service used, refers to any outsourced third party vendor, investor, or internal lender department that may be used for the draw administration of renovation loans.]
Does the draw administration service used commit to getting projects complete and not just pay down incomplete projects to stay within guidelines?
Success on a renovation loan is not attained at closing. Success can only be celebrated when the renovation project has come to a successful conclusion. Lenders should see the closing of a renovation loan as the first step to a successful loan. Once the project is complete the celebration can take place for a successful loan. This is why it is so vital that the projects move forward to a successful conclusion. Any renovation project which results in work not being completed as planned and where a large balance of the renovation funds are paid down (aside from contingency reserve funds) to principal to “close out” the project to stay within agency parameters is a failure. Regardless of how “easy” the closing may have been, if the borrower’s aren’t living in the home they envisioned at purchase by the time the renovation is closed out, the loan was not a successful loan.
Does the draw administration service used have experienced staff to accomplish the goal of successful completion of the renovation project? Can they deal with the issues that will come up on 50% to 60% of the projects?
Lender research has shown that borrower’s experience issues and disruptions on their renovation projects over 50% of the time. (Some of the vital feedback that needs to be identified.) Draw administration must deal with these issues on a consistent basis to resolve the borrower’s issue and still provide a good experience for the borrower. This can be a tricky path to negotiate which requires experienced draw administrators to navigate and deliver to a successful conclusion for the borrower.
There are 3 options lenders can use for management of draw administration. They can service the draws internally with their own department, they can hire an outsourced third party vendor, or if they sell the loan to an investor.
Some investors may manage the draw process directly and others may use an outsourced service or allow the lender to manage the process, requesting funds from the investor for disbursement. Those 2 options will have the same pros and cons as outlined and will also fall into one of the 3 main categories described below.
Lenders may determine to have their own internal draw administration department. This is the choice of many lenders who securitize their renovation loans or those which desire to “keep control” of the draw process when selling to an investor. When determining if this is the best option there are a few items to consider.
Does/Will the internal staff have the experience to get projects completed in a timely manner and do so while delivering a good borrower experience?
It is important to focus on ensuring the draw administration staff has the experience to handle the draw process in an efficient manner. This includes setting up a process for consistent contact with parties, fund control, and managing issues that come up on the projects pertaining to proper code requirements and borrower/contractor disputes, just to name a few. It is imperative this service delivers a good borrower experience to optimize the full benefits of the program that have been outlined earlier.
Will the income derived from the process cover the cost of the staff needed to complete the process and deliver a good borrower experience?
Renovation programs have an option to charge a borrower for the management of the project. The fee will vary by program, but is designed to cover the cost of draw management. Lenders must determine if the fee income derived covers the cost of their provided service. This may be dependent on volume, but high renovation volume does not mean the fee income covers the cost. If the service is not being provided in an efficient and professional manner, the draw service will erode profit and referral benefits.
Outsourced third party service
Does the cost of the service offset the income derived specifically from draw administration?
There are various third-party services which lenders can employ for draw management. Lenders will use these services to allow them to securitize the loans internally, in lieu of developing an internal department for draw management. Often, this is the initial step for lenders as volumes may be insufficient to support the development of an internal department. Lenders must consider the cost of the service as well as the quality of the service provided. If the cost of the service is more than the fee income derived from the loan which covers the cost of draw administration, then the service cuts into the true lender profitability.
Does the vendor provide a service that is truly adding value to the program?
On renovation loans, 60% of the difficulty of the loan, when taken from origination through project completion, occurs post-close, during the project phase. This is why it is so important that the service provided post-close delivers the benefits important to the lender to obtain referrals and leave the borrower with a good experience of the overall process. If the outsourced service is not delivering these values, the cost of the service may be more than the actual dollar amount being charged in reputational damage and lost referrals. Lenders should consider this carefully to ensure they are obtaining the referral benefits and as importantly, receiving the market reputation they desire.
Does the investor have long term experience in management of draw administration?
The vast majority of lenders offering renovation lending utilize the investors they work with to manage the draw administration process. All of the key items in the last 2 sections also apply to the investor managing the draw process. The investor’s process should be a compliment to the lender’s original origination services, providing a good borrower experience from origination through project completion.
Lenders should ensure their investor has the expertise to deliver a good borrower experience. Due to recent market conditions, many lenders and investors have “jumped into the renovation lending pool.” Some investors do not understand the complexity or importance of the draw management process and simply look at the program as another offering. As mentioned earlier, renovation lending is not just another program and must be looked upon as a platform that requires the appropriate diligence to perform properly and to full profitability
How long have they been doing these programs on an investor level?
Lenders should question potential investors on their experience with the programs. Investors may have purchased or hired an existing renovation department or personnel to help develop the program, but those groups are only as good as the previous company they worked under. Lenders should work with investors who have experience managing the draw process for their clients and ensure the investor’s goals align with the lender’s goals. A poor investor draw management service can be a detriment to the lender receiving referrals and stunt the growth of the program for the lender!
Do they provide feedback on the process?
Investors should be able to deliver quantifiable and documented results of their process and program. Important metrics such as those noted below are key pieces of information lenders should know:
- The percentage of projects that exceed their original completion date and the main reasons for those results
- The number of projects actually brought to full completion versus the number of projects not completed
- Borrower perception of the draw process and of the original lender’s process
- Repurchase and indemnification requests over the last 12 and 24 months based on project issues
- Total number of projects managed over the prior 12 and 24 months
These are all key aspects of the draw management process and ones which lenders need to know to select a renovation lending partner.
Securitization or Sell to an Investor
Larger lenders who have their own servicing platform for loans, may desire to include renovation loans in their servicing platform. All the items mentioned above should be taken into consideration when making this determination. One item that has not been discussed and that has been intentionally left as the final discussion topic, is price. Price is an important aspect of any renovation lending program, but as the items above illustrate, it cannot and must not be the only consideration.
Lenders should also consider the volume of renovation loans. For the largest renovation lenders in the country, the percentage of renovation loans still represents a tiny percentage of the overall monthly production. Is it worth the work, time, and effort developing the draw administration department and boarding the loans on the servicing system, when they tend to refinance at a faster rate?
Securitizing renovation loans and servicing them will generally provide the best raw price to the lender, but that also puts all the risk on the lender. The agencies that offer the different renovation programs generally do not price renovation loans any differently than non-renovation loans. So lenders can obtain and achieve full securitization pricing for the loans.
Renovation loans do present more risk than non-renovation loans. The loan is based on a value that does not exist at the time of close and if the work is not completed as planned, the value may not support the loan amount, even if there is a principal payment made of remaining renovation funds.
Additionally, there is risk of the borrower and/or contractor not following the plan or acting in prescribed original terms. This can cause projects to go out of scope and again there may be valuation or property eligibility issues that don’t meet agency requirements. This emphasizes the importance of efficient and proper draw management.
These are just some of the risk items associated with renovation loans and why it is important to have an experienced draw staff involved in these programs. Lenders determine the “risk assessment” of the programs and apply a price adjustment to help offset that risk. Renovation loans cannot be valued just as any other loan, due to these risk layers and often times they are originated at slightly higher interest rates to mitigate the risk.
This causes another issue to develop. Depending on mortgage market conditions, renovation loans tend to refinance quicker than non-renovation loans, due to the slightly higher rate. Lenders can’t apply the same servicing value to the loan as they would a non-renovation loan or risk a loss on that loan if it refinances too soon. Lenders who do not appropriately manage this price/risk/servicing will find themselves in financial distress with regard to their renovation lending portfolio. This may be a reason for some high turnover in the number of lenders offering renovation lending over the last decade who were considered major players and left the space even though the market has become stronger for the product.
NOTE: This report is not naively trying to say selling a renovation loan will produce the same profitability result as securitizing the loan. The point is there are many additional markers that should be addressed when looking at total profitability of a renovation loan in addition to the raw market price.
Sell to investor
Lenders which will partner with an investor for their renovation program will need to examine the experience and platform of the investor. Lenders can’t treat the best execution model the same for renovation loans as they do for non-renovation lending products. Secondary and Capital Markets staff must take other costs and factors into account when determining the best execution for their company. This will include determining draw administration costs, depending on the model being utilized. The execution model must take into account the servicing items of draw management including borrower experience, successful completion of projects, etc. Ignoring those items and forgetting about the loan once it has been purchased by the investor is not ultimately generating a successful model. Regardless of the choice of investor, if that investor is not providing a good borrower experience, it can damage the relationships built by the origination team and lead to issues in retaining sales staff.
Price vs cost
Securitizing lenders and lenders selling to investors must analyze the final price of the renovation loan compared to the costs taking into account the risk, servicing factors, and operational performance metrics required to successfully offer the program. The cost analysis must include the added cost for origination, training, compliance, systems, etc. It must also include the hard costs for staff managing the draw administration, training for that staff, and costs which cover the intangible items of borrower experience, customer satisfaction, and referral pull through. Securitizing lenders will need to determine all these items on their own, while selling lenders will need to analyze the investor partner’s platform and experience to determine the best renovation partner.
Lenders may find that best execution, when taking all of these factors into consideration may not be the option that supplies the best raw price for the loan.
Regardless of the method used by lenders for renovation lending, the points are consistent. Superior service in the management of the renovation project leads to more business and more profitability. Whether a lender securitizes or sells the loans, develops their own internal staff, utilizes a third party, or investor, the lender must know the quality of the service being delivered if they intend on capitalizing on all the benefits renovation lending programs offer.
Regardless of the draw service system used, if you are offering renovation lending, address and account for all the points discussed to ensure true profitability goals and obtain all the benefits and profitability renovation lending has to offer.