Most contractors find that people who finance home improvements tend to spend more than those who pay cash. Contractors who understand the various types of credit products and know how to present them will be more likely to lead the customer to make the decision to finance.
First, however, you must determine whether someone is a candidate for financing. The only accurate way to do that is by asking them to fill out an application, and to pull their credit score. Some salespeople try to pre-qualify prospects on “instinct,” taking cues from things like the car in the driveway or the condition of the home's exterior.
According to Matt Hines of American Eagle Builders in Arlington, Texas, that's a sign that the salesperson isn't doing his job, which is to listen to the customer, look at the numbers, and offer solutions. “We had one salesman who refused to follow up on a lead because the house looked old. Another guy went there and got a great deal.” And the tendency to prematurely judge prospects isn't confined to home improvement. “I used to be in the car business,” Hines says. “One day, a guy pulled up to the dealership in an old Cadillac diesel that was probably worth $500. No one else would wait on him, so I did. It turns out he owned five banks and became my best customer. He bought every vintage sports car that came through that dealership.”
On the flip side, don't automatically assume that someone with plenty of cash is not a candidate for financing, advises Michael Gorman, whose Lakeland, Fla., company, TechKnowledge, trains contractors in sales, marketing, and estimating. Gorman was a contractor in Denver for 20 years, and although he had great success offering financing, he could never predict who would take it. “I have had wealthy clients who wanted to liquidate their investments to pay for the job, then changed their mind after talking with a financial adviser,” he says. “That made them a good candidate for financing.”
Photo Credit: David Plunkert
PORTFOLIO SELLING
You are more likely to sell a prospect on financing if you can talk intelligently about the pros and cons of different financing products, and if you understand which one is most likely to solve their particular problem. The more credit options in your portfolio, the more success you will have. What follows is an overview of the most common credit products, along with some tips for using them.
Credit cards are an obvious choice for small jobs, especially if your salesperson needs to close the sale on the first visit to the home. And since everyone knows how credit cards work, they don't need any explanation. Accepting them is an easy way to help people say “yes.”
But you can also use plastic to sell larger projects. Gorman says that the frequent flier miles that many credit cards offer are a great way to close sales with people who like to travel. “If a customer balks at a $200,000 bid for a remodeling project, we say, ‘What if we can also offer you two round-trip tickets to Europe?'” Then Gorman shows them how the miles they earned with the purchase will pay for those tickets. If they don't have a card that offers miles, he tells them they should get one. Then he suggests that the customer get a lower-interest installment loan to pay off the credit card. If their card offers a $20,000 credit limit, he lets them pay in $20,000 monthly increments.
The downside, of course, is the charge to the contractor. Gorman says that Visa and MasterCard charge 3.5% of the sales price, which means that the job costs more. “I can only make that work if I go in at a high enough price,” he says.
Revolving credit accounts work like store credit cards but without the plastic. They're a good way to generate repeat business because you're the store: Customers can only use these accounts with one of the finance company's authorized contractors.
Revolving accounts are used to finance everything from $200 handyman jobs to $30,000 bath remodels. They may be secured or unsecured depending on the lender, but once the customer has set up an account, they can use it again and again.
Rates vary from prime +3.99 points to prime +14.99 points, depending on the customer's credit score. The contractor usually doesn't get paid until the work is done, so this type of credit is best for smaller jobs that are done quickly, such as replacement windows or siding.
Some lenders have payment schedules where, like with a credit card, the payments decrease with the balance. The downside is that if homeowners make only the minimum payments, they pay more interest over the life of the loan. Other lenders set the payment at the time of the draw and keep it there until the customer borrows more money.
Unsecured installment loans are most appropriate for jobs priced in the high teens to the low $20,000s, although amounts can range from $5,000 to $50,000 for customers with great credit. Interest rates are lower than for revolving accounts, and terms can be as long as 240 months.
The closest analogy is a car loan, where payments stay the same throughout the life of the loan. Say you have a $10,000 window job with monthly payments of $200. If you pay it down to $6,000, you will still be paying $200 per month.
Same-as-cash credit promotions are mostly used to close a sale when the customer is able to come up with the entire job amount after a predetermined time. But they can also be a great fit for a customer who wants to sell a home but needs to make some improvements to make it marketable. “With same-as-cash they can get a new kitchen with no money down,” Gorman says. “The price of the job will be paid off with proceeds from the sale, and the kitchen will help the home sell faster and for more money.” He says that this tactic works best with kitchen remodels which, according to REMODELING'S annual Cost vs. Value Report (see page 65), recoup a high percentage of cost upon resale.
Photo Credit: David Plunkert
A secured home improvement loan backed up by a second mortgage can be presented to customers in a way that shows them how it can help with other expenses. In many cases, the interest is also tax deductible. “Say they have a $50,000 project but they also have a $30,000 tuition payment and a lease on a car that's worth $20,000,” Gorman says. “The tuition and car payment aren't tax deductible. You tell them that they can borrow the first $50,000 to do the remodeling, and the next $50,000 to pay off the car and college loan. All of their interest is now tax deductible.” This type of loan also carries the lowest interest rate, and payments can be spread out over 20 years or more.
Average job size is around $30,000 according to Bruce Christensen, vice president for Home Improvement at GE Money, and the contractor can set up a draw schedule. In some cases, the lender will make a secured loan for up to 125% of the home's value. “We don't consider this to be risky,” he says. “We're looking at the value of the customer — and property values will go up again.”
A secured loan may also be best for someone with less than perfect credit. “If a customer is rejected on an unsecured loan, we try to get them to apply on a secured basis,” says Rob Levin, president of Statewide Remodeling in Grand Prairie, Texas. In fact, he often presents customers with an option for both a secured and an unsecured loan. “Rates are lower on a secured loan. On the other hand, some people don't want to use their property as collateral.”
Getting a secured loan takes longer and requires a fair bit of paperwork. Because of this, some remodelers pass on smaller projects where the client can't get an unsecured loan, according to Levin. He thinks they're nuts. “We are not walking away from a $10,000 or $12,000 project because they have to fill out some forms.”
Partial self-financing is something most contractors don't consider, but it can increase the profit on a job. “I have done jobs where the customer wanted to build a $20,000 project but only had $15,000, so I financed the extra $5,000,” Gorman says. “What I'm basically doing is financing my profit.”
Gorman sets up a simple LLC (limited liability company) to hold a second mortgage on the house at a higher rate than the first. “You can do this a couple of times a year. As time goes on, you will create a substantial side income.” He says that he did this three or four times per year over 15 or 20 years and never lost a dime.
Refinancing with a new mortgage is not as easy today as when property values were skyrocketing and interest rates were low, but it's still appropriate in some cases. “Even today, you see some people with higher-than-market interest rates and a lot of equity, which makes this a viable strategy,” Gorman says. That makes it a good idea to ask prospects about their current interest rates when talking about financing options. Some people will include extra cash for investments if they can get a higher rate for that money than they are paying for the mortgage.
Photo Credit: David Plunkert
Financing on the improved home value is where the lender lets the borrower refinance for the projected value of the home after the improvements have been completed. It's only appropriate for large projects, and it requires that the contractor have some market knowledge and financial sophistication.
Some lenders are more aggressive about chasing these loans than others. For instance, Countrywide Financial has a formal One-Time-Close program for large remodeling projects where the cost of the renovation is 50% to 60% of the existing value of the home. It's a combination construction loan and mortgage, according to Al Dimoush, the company's executive vice president of National Construction Lending.
Say that your customers have a home worth $500,000 and they want a $300,000 remodel, including some interior work and an addition. An appraiser determines that the completed house will appraise for $800,000, so they get approved for $720,000, which is 90% of the appraised value. At closing, $400,000 goes to pay off the underlying first mortgage. The remaining funds are drawn out as the project progresses. During construction, the customer makes interest-only payments. They start by paying interest on the $400,000, then on increments as the construction loan is drawn down. When construction is complete, the loan automatically converts to a permanent mortgage.
This doesn't work for smaller renovations that will not sufficiently increase the home's value. It's also not the best proposition for borrowers with low first-mortgage rates. If someone has a 5% first mortgage, it makes little sense to pay that off with a 6% or 7% loan.
The contractor needs enough market knowledge to predict the value of the completed house, as well as a working relationship with a good appraiser. “We see problems when the borrower or builder doesn't clearly communicate the scope of work to the appraiser,” Dimoush says. “This includes big mistakes, like not accurately defining the square footage, or smaller ones, like [getting the wrong] specs for flooring. It's important that the appraiser knows exactly what needs to be done.”
This type of financing is also used by buyers who are considering buying a home but will only do so if they can borrow enough to make the improvements they want.
Keith Steier, president of Knockout Renovation in Manhattan, finds that a lot of these people don't actually end up buying, so he now charges a $300 fee for preparing the estimate for them to bring to the bank. “We started doing it about a year ago,” he says. “We get calls for estimates three or four times a week, but a lot of them don't want to pay the fee. It weeds out those who are speculating or are not serious buyers.” If they end up hiring his company to do the work, he credits the fee toward the job.
There's often more to credit products than what's on the surface. With a little creativity, you can learn to use them in ways that bring you jobs you might otherwise have lost, as well as profits you'd never considered.