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How Lenders Can Hone Their Competitive Edge in a Business of Uncertainty

September 7, 2023

When it comes to construction projects, the old adage rings true: Time is money. From start to finish, every stage of a build is susceptible to myriad delays, missed opportunities, poorly managed risk and widespread inefficiencies. These all impede a project’s cost-effectiveness and threaten to sour the relationship between lender and building partners, i.e., an originator’s most indispensable referral source.

Thanks in part to a decently strong economy and developments, 2019 was a steady year for the construction business, and experts are cautiously optimistic that 2020 will continue the trend. However, uncertainties around predicting and managing risk continue to plague the industry, mostly due to labor shortages, rising material costs and overall project delays.

With this in mind, lenders will need to focus on how to gain an edge on their competitors, particularly if project rates slow down in the second quarter of 2020. To keep pipelines stable (if not robust), lenders will need to maximize their relationships with referral sources via hypervigilant and punctual funds management. The formula is simple: Proper planning plus solid funds management equals faster payments, ultimately resulting in happier referral sources. 

Proper planning mitigates risk

The aftermath of the Great Recession has precipitated the implementation of tighter regulation over the mortgage lending industry, most notably in the form of TRID, or the “know before you owe” rule, which has laid out a framework of tolerance thresholds for closing disclosures offered by lenders. Essentially, TRID was enacted in order to ensure that loan originators disclose a loan’s terms with transparency and accuracy from the outset of the loan’s lifecycle. 

While this has created a better safety net for consumers and builders, mortgage lenders are faced with the complex and somewhat daunting task of not only interpreting the nuances of TRID’s rules while also balancing risk and navigating changing circumstances.   

Because there is so much variation between construction projects, an inaccurate costing review assessment is one of the most common sources of tolerance violations because it can cost a lender thousands of dollars in fees per year. For example, the projected budget on a new home could fall short, causing construction to languish for months.

Another common problem area for tolerance violations is insufficient contractor review. Also known as builder validation, the review process is meant to take a close and comprehensive look at a builder’s credentials and experience to determine whether they are qualified to deliver a given project from start to finish. Further, contractor review adds an extra layer of protection for the lender by ensuring that a contractor is licensed, has the necessary insurance and has up-to-date policies.

Systematic funds control, better referrals

Responsible funds management is not simply a key component in keeping construction on schedule — it’s also crucial for keeping contractors happy and ensuring a healthy relationship between lenders and potential referral sources. Because there are so many draws during a project, there are many opportunities for missed or delayed payments, so funds must be administered responsibly and vigilantly. 

Further, a sound funds management system protects the lender’s investment by ensuring that money is being allocated to the correct line items and not being diverted inappropriately or mismanaged by the contractor. Binding each draw to specific progress in the construction schedule helps minimize the risk that a project will be delayed or go over budget. Contractors typically prefer to see a draw at close, which helps them to pay for materials or work already processed by the contractor. It also provides for deposits on key materials and improves their cash flow.

The fund control process is another area susceptible to adding risk; for example, a client might work with the builder to change the scope of various items in the budget without informing the lender. Proper evaluation of change orders for each draw request prevents costs from increasing without the lender’s knowledge. 

One platform to manage it all

Because projects vary so greatly in size, scope and overall logistics, lenders face the burdensome endeavor of balancing compliance while maintaining efficiency and enhancing scalability. Thus, one of the most critical components of a construction lender’s toolkit is their draw management process. With the right platform in place, a lender dramatically increases their ability to minimize risk, safeguarding the originator’s financial and legal interests while boosting the efficiency of their loan initiatives and lowering barriers to close. Heightened efficiency naturally improves a lender’s ability to scale; all of these components come together to maintain and strengthen business relationships with valued referral sources.