Renovation lenders breathe new life into existing structures
by Robert O'Connor
As the booming mortgage market pushes homeownership rates to record levels, banks would be well advised to look closely at lending opportunities for residential properties in need of renovation.
The rehabilitation sector offers particularly good prospects for community banks. It is relatively easy to get into. It can lead to the cross selling of other products. And, with its strong focus on affordable housing, it can enable a bank to build relationships with minorities and other groups that previously might not have been well served by the financial services industry.
Renovation-based lending also meshes well with the Community Reinvestment Act, which requires banks to invest money in areas in which they operate. “It [the CRA] has helped a lot to redevelop areas that were in disrepair,” says Hilde Dewulf, program director at Lincoln Neighborhood Redevelopment Corp. in Milwaukee.
For University National Bank, in St. Paul, Minn., renovation lending offers a way to combat a local shortage of housing. David Reiling, CEO and president of University National, says that the shortage is especially acute in affordable housing. Reiling sees renovation lending as part of University National’s strong social commitment. Getting vacant houses back into use, he believes, makes for stronger communities.
“It’s a large market for us,” Reiling says. “We do a lot of rehab lending in the more traditionally underserved or low-income neighborhoods. There always seems to be the need to rehab a house.”
University National started its Houses to Homes program in May 2000 and is well ahead toward its goal of 1,000 rehabbed homes by 2005. “We won’t be at a thousand by the end of this year,” Reiling says. “But we will be getting darned close.”
Fannie Mae’s HomeStyle Renovation mortgage product is designed for the rehab market. Jim Matheson, HomeStyle’s senior product manager, calls it “a complete solution for home renovation financing.”
HomeStyle Renovation, Matheson says, “allows the borrower to combine the home purchase or a refinance with home improvement. And the financing is all done on one loan at one closing.” The product has been on the market since the late 1990s. While it is available for both purchases and refinancing, the typical loan is for a purchase. The advantage of using HomeStyle for improvements to a dwelling in which the borrower has been living is that it is cheaper than a second mortgage.
Matheson says that all types of improvements or renovations are allowed as long as they are fixed to the foundation. The loan can also cover up to six months of rent if the family has to leave while the work is being done. And there is a provision to cover a cost overrun of up to 10 percent. “It’s a very attractive program,” Matheson says.
Under the HomeStyle product, a property is inspected to establish its value. The borrower selects the contractor, who would submit plans to the mortgage lender. An appraiser would use these plans as a guide to an as-completed value estimate. The lender would use this estimate to calculate the size of the loan.
The renovation costs are put into escrow and paid to the contractor in stages as the work is completed to the borrower’s satisfaction. The lender ensures that the work is done and provides Fannie Mae with a certificate of completion. “The nice thing about this loan,” Matheson says, “is that it really protects the borrower, which is one of our major concerns.”
Fannie Mae will want to satisfy itself about the bank’s mortgage portfolio size and its experience in renovation lending. From the bank’s perspective, qualifying for the program is not difficult. Matheson says that a community bank is likely to be well placed to participate.
Dewulf, of Lincoln Neighborhood, says that the creation of a secondary market for renovation mortgages was a major step forward for the sector. Lincoln Neighborhood, which has been doing renovation loans with its own portfolio money for about 10 years, was preparing to offer the Fannie Mae HomeStyle product as of August.
The company, which has nonprofit status, is part of Merchants and Manufacturers BanCorp., in Brookfield, Wis., which owns nine banks. Lincoln Neighborhood does not make loans, but assembles them for banks. The company, which serves a largely Hispanic customer base in a small area on the south side of Milwaukee, gets a lot of business by word of mouth.
For now, the company plans to promote HomeStyle cautiously, lest it get swamped with applications. “We will see how it goes,” Dewulf says. “If it really takes off then we will add staff.”
Art of Rehab Lending
Success in the rehab market calls for care both in the vetting of applicants and the structuring of deals. University National looks for borrowers with rehab experience, liquidity and creditworthiness. It will lend up to 100 percent of the purchase price if an appraiser pegs that as 75 percent of the value of the renovated building. This means that a 100 percent loan on a $100,000 purchase would be based on the expectation that the property would be worth $133,000 after it is fixed up. The bank places no restrictions on how soon the buyer can sell the renovated property.
Reiling says that borrowers with rehab experience are better able than novices to identify what needs to be fixed. They are also likely to have the funds to cover the renovation. These are important considerations in the St. Paul-Minneapolis area, where much of the housing stock dates to the late 19th and early 20th centuries.
University National hires the contractors and keeps close track of their progress. Previously, the bank had left this detail to the new owners. But this often didn’t work out. House buyers have other things on their minds, such as their day jobs. Amateur renovators can be thrown psychologically by the sudden discovery that their dream home needs new wiring or new plumbing. The all-too-often result was delay.
Reiling says that the bank is starting to track who is buying these homes. His strong impression is that most of the buyers are people from within or near the neighborhoods in which the houses are located. As good as the deals may be, he said, that they are unlikely to attract suburbanites to the inner city.
University National Bank is looking for a way into the secondary market. This will involve streamlining the link between the rehab loan and the permanent financing. With the appraisal and the title work in hand, Reiling says, “it’s just a matter of making it fit into the box of the secondary market.”
Dewulf said that any bank considering offering renovation mortgages should make sure that it is very familiar with its market. “We concentrate on the area that we know, that we have been working in for 10 years,” she says.
Lincoln Neighborhood’s refurbishment loans average between $70,000 and $80,000, with the rehab share running at between $10,000 and $20,000. The city of Milwaukee offers renovation grants of up to $8,500 for three-bedroom units. The recipients must match the grants and remain in the homes for five years.
The company, which has just had its first foreclosure in 10 years, minimizes its risk exposure by its careful lending policies, Dewulf says. Borrowers are required to make a downpayment and must demonstrate an understanding of “what needs to be done,” she says. Beyond that, the company visually inspects every building before purchase and does not pay the contractors until the work is completed.
“Most of our loans have had excellent repayment records,” Dewulf says. “And we want to keep it that way.”
Robert O’Connor is a free-lance banking writer.