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
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
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.
This Perfomance Study Research