Financing Q&A

Does offering financing make a remodeler into a mortgage broker or a bank? Is there any investment risk? Lenders and remodelers answer these and other questions that are commonly asked by contractors contemplating offering financing. The list is not comprehensive, but it covers the essentials of what to expect when adding a financing option to your business.

Q: Why offer financing?

A: To sell more jobs — and at higher prices.

Some remodelers begin offering financing after seeing too many potential projects killed when the homeowners get frustrated waiting to find out if they would be approved for a loan. “Fast credit decisions are critical to the success of [any] consumer financing program,” says Paul Jones, vice president of operations at Wells Fargo Financial Retail Services. “For a remodeler, a delayed credit decision could mean the difference between winning or losing a job.”

Remodelers who offer financing also tend to get more lucrative projects. A homeowner is likely to spend more on a project that can be financed, for the simple reason that the cost can be spread out over time. That's why remodelers who are successful selling financing tend to talk in terms of monthly payments. “It's easier for the customer to swallow a $695 per month payment than a $200,000 nut,” says Bob Kocis of LIRemodel.com in Huntington Station, N.Y. The payment increase on an extra few thousand dollars may be comparable to what an affluent customer spends each month on take-out coffee.

Q: What criteria do lenders expect the remodeler to meet?

A: Most national lenders will deal only with an established remodeler who has been in business for three to five years. Many also review the remodeler's financial statements and insurance records. “We conduct due diligence on each [company that applies],” says Tom Hewitt of AmeriFirst Home Improvement Finance. “We want to make sure they will install products in a workmanlike manner.”

Some lenders even perform background checks to see if there's a history of litigation, or only deal with contractors who meet a minimum sales volume requirement. For instance, KeyBank Home Improvement wants the contractor to have a commercial location, annual sales of at least $500,000, and a net worth of at least $50,000.

Q: What should remodelers expect of the lender?

A: Remodelers should be careful about lenders to which they send their customers. The lender's customer service should be as good as yours. If a customer has a bad experience with a lender you referred, that sour taste in their mouth will have your name on it.

Besides comparing interest rates and fees, stick with lenders that have worked with remodelers. John Murphy, president of Murphy Brothers Designers and Remodelers of Minneapolis, says most of his customers finance their projects through his sources, but he has had trouble in the past with credit unions that aren't used to funding home improvements. “We don't want the project derailed by a lender that doesn't know what [it's] talking about. So we only use [financial] products geared toward remodeling.”

Another caveat is to make sure the contract clearly spells out when you will get your money and how. “We have a list of stipulations we expect the bank to follow, including a 30% down payment, payment by wire transfer, commitment to have inspectors at the jobsite within 48 hours after we call for an inspection, and final payment within 10 days of completion,” says Robert Weickgenant, president of Star-Com Design/Build Corp. in Columbia, Md. “If you leave the bank in control of all this, they'll kill you.”

Q: How many alternate lending sources should you have?

A: Almost all of the remodelers we spoke with had relationships with more than one lender. This enabled them to serve a wider range of customers. For instance, most had a first-tier lender — either a bank or a finance company — along with a second-tier option for credit-challenged customers. (See “Backup Bucks,” page S126.)

Q: Should your primary lender be local or national?

A: Some remodelers say that they get more business by offering multiple sources. That's because certain customers are more comfortable with more choices. Some customers want local contacts; others are more interested in competitive rates.

However, if you're a young company your only choice might be a local lender. “They will probably approve you more quickly than a national company,” says Mark Richardson of Case Remodeling in Bethesda, Md. “Then, as your company grows, doors will open to the national companies.” However, a national company might be a good choice if your customers are brand conscious.

Another option is something like the Home Projects Visa card from Wells Fargo Financial Retail Services. The card can only be used to pay contractors and home improvement retailers that are approved for the program. Participating contractors can offer the card to customers, who can then use it to pay for their home improvements. Revolving credit lines up to $25,000 are available to approved cardholders.

Q: Should I work with a mortgage broker?

A: Unlike agents that work with just one lender, a mortgage broker will originate and process loans for a number of lenders.

Remodelers' experience with brokers varies. Allyn Harth of Harth Builders in the Philadelphia area provides financing through GE Money's sales finance division and GB Home Equity. Before contracting with those lenders, he was approached by a number of brokers whose comparatively high interest rates — he saw numbers ranging from 12% to 25% — scared him off.

Others say that a broker who understands the home improvement market can be a great asset. “A broker knows how to match the customer with the right bank, based on that customer's needs,” Weickgenant says.“The same way that we know how to match them up with the right tradespeople.”

Q: How much training do you need to sell financing?

A: Most lenders provide both an initial training session and ongoing support. The content and extent of the initial training vary by lender but could include everything from product types (what to offer when) to how to incorporate financing into a sales proposal to how to process the paperwork. Geoff Chang of KeyBank Home Improvement says the company's account executives usually spend two hours training a new dealer's salesforce.

This may not sound like much of an introduction, but lenders say that remodelers don't need a lot of knowledge. The lender does most of the heavy lifting and will teach the remodeler's salespeople everything they need to know, including how to make the offer and how to read a credit chart with APRs, ticket sizes, and monthly payments.

Q: How much information do you need to ask customers?

A: First-tier lenders say that, for the customer, the application process requires more information than a credit card application, but a lot less than a mortgage.

If you have multiple lending sources, it's a good idea to qualify customers yourself. For instance, Murphy asks customers basic questions about income, debt, equity in the home, and credit history. This information helps him decide which lender to steer the customer toward, reducing the chance of rejection.

Q: Does the remodeler have any liability if the borrower defaults on the loan?

A: Remodelers aren't liable if the customer defaults unless, of course, they are offering some sort of in-house financing (see “Loans of Your Own,” page S134). However, the finance company can hold the contractor responsible for getting the work done. “If a customer complains, and the contractor chooses not to fix the problem, then I can ask him to buy the loan back,” says Bruce Christensen, vice president of GE Money's home improvement division. “But we have found that even if a customer does log a dispute, 96% of the time it's resolved in favor of the contractor.”

Q: Does the remodeler have to pay for the privilege of offering financing?

A: Some lenders require a nominal fee — usually $100 or less — for remodelers to come onboard. From that point on there are usually no costs. The exception is for deferred payment loans. Some lenders allow the remodeler to offer promotions that let customers defer the first payment for a set period — which could be as little as three months or as long as a year. In these cases, the remodeler is charged a fee based on the length of the deferment period.

Q: Does the remodeler make a profit from the loan? If so, must he disclose this to the homeowner?

A: The anti-kickback federal law known as RESPA (Real Estate Settlement Procedures Act) prohibits contractors from making money off finance referrals for secured transactions. However, it doesn't apply to unsecured transactions, which are generally used for loans below $25,000.

Builder Direct Lending offers a commission to contractors who are willing to do a little extra work. The contractor signs on as an “agent,” and is able to get direct, computer-generated quotes from various lenders without having to talk with a loan officer.

The contractor performs services such as explaining the benefits of various loan products to customers, taking the loan application from the customer, ordering title search, closing, and other services.

“This fulfills the RESPA requirement to earn additional revenue,” according to Terry Gilliland, the company's vice president of business development. The agent commission is currently one half of 1%. He says that some contractors keep it as income, while others pass it on to customers as a savings.

Q: What are the most common questions customers have about financing and how should they be answered?

A: “Customers always ask about monthly payments,” says Dave Anderson, a regional sales manager with GE Money. He says that a ballpark rule of thumb is that their monthly payment will be about 2% of the total job cost on an unsecured loan and 1% to 1.3% on a secured loan.

Some customers also ask about their obligations if approved. Lenders say that until the customer signs off on the loan they have no obligation to use it.

Backup Bucks

If your customer isn't a prime candidate, there is still plenty of money available, but it will come at a premium.

No one knows exactly how much potential business remodelers lose because of credit issues, but casual estimates we've heard from finance companies range from 27% to as high as 50%. That's where sub-prime lenders come in. These companies specialize in financing home improvement projects that first-tier lenders reject. Any remodeler offering financing should have a relationship with one or more of these lenders.

First-tier lenders use automated underwriting systems that put great weight on an applicant's FICO score. The score, developed by California–based Fair Isaac & Co., can range from 300 to 800. According to Fair Isaac's Web site (www.myfico.com), median scores are around 723, and someone with a score of 760 or better will pay $231 less per month for a $216,000 30-year, fixed-rate mortgage than someone with a score below 620.

While all lenders look at FICO numbers, sub-prime lenders consider other factors to paint a more comprehensive profile. “Our underwriters evaluate each applicant's financial capacity, collateral, and character,” says Tom Hewitt, president and CEO of AmeriFirst Home Improvement. “That's how finance companies used to work 20 or 30 years ago.”

In fact, Bill Simone of HomePlus Finance, a sub-prime lender based in Los Angeles, says that while most first-tier lenders won't consider someone with a score below 600, his company recently financed what he calls “a new low” — someone with a score of 439. “Our analysis told us that there was nothing in their credit to indicate that they wouldn't pay us.”

Some of this flexibility stems from the source of the funding. Sub-prime lenders generally lend money from private investors, so they can take a bit more risk than either banks, which are regulated by the FDIC, or finance companies, which must answer to their shareholders. “We use our own money so we can tolerate higher losses,” Simone says.

But flexibility comes with a price for the borrower and the remodeler. The increased risk coupled with the higher return private investors are looking for mean the borrower has to pay a higher interest rate, which will vary according to their profile and the loan amount. That's why sub-primes tend to be the second or third choice among borrowers.

The lender may not release any money until the work is done, which is why this type of financing is more commonly used by replacement contractors, who are in and out of a house relatively quickly.

Because the sub-primes depend on their contractor dealers to fund the construction phase, they may also scrutinize contractors more closely. They want to know that the contractor will install products in a workmanlike manner and that he has the financial stability to wait until the job gets done for payment.

For many contractors, the extra business made possible by working with a sub-prime lender is well worth the effort of learning to live with the added requirements. And if alternative financing makes it easier to get new work, the contractor may be able to spend less on marketing and advertising. That can more than offset any costs associated with carrying jobs. As Simone puts it: “The cost of leads these days is too expensive to throw any one in the trash.”