As property values fall nationwide and lenders put more scrutiny on borrowers, more of your customers may get turned down for financing from first-tier lenders such as Wells Fargo or Bank of America. But that doesn't have to put them out of the game. Second-tier, or “subprime,” lenders specialize in loaning money to people who first-line lenders reject. A relationship with one or more of these companies, along with a system for managing the sales team and the homeowners, can often save the sale.
Matt Hines, president of American Eagle Builders, an exterior contractor in Arlington, Texas, says that working with a subprime has been a boon to his company. “About 40% of our customers get turned down [for conventional financing],” he says. In the past, most of those customers were lost, Hines says, but that changed after he started working with HomePlus, a subprime lender based in Los Angeles. “About 80% of our customers now get financing. They finance a lot of the deals we used to lose.”
Photo Credit: David Plunkert
Interest rates for these customers are higher than for someone with good credit, but since the loan is usually secured by a second mortgage on the property, the rates are still lower than for a credit card or an unsecured loan. HomePlus president Bill Simone says that his company's rate for a secured loan is 10 points over a Treasury bill with a comparable term. So if T-bills are offering a 4% return, he charges an interest rate of 14%. By comparison, someone with good credit would pay in the 9% to 10% range.
In most cases, the second-tier lender will make a decision within a few hours, but the paperwork can take longer. “The only thing we need before making a decision is a signed application and a copy of the work order,” says Butch Dickson, president of Community Home Financial Services, a subprime lender based in Jackson, Miss. But, he adds, completing the loan can take several days. “We have to perfect our lien [on the property] and document the customer's income,” he says. The lender has to order a copy of the house title, and the customer has to fill out the same forms and provide the same documentation as for a first mortgage: paycheck stubs, bank statements, etc. Then they have a three-day right of rescission.
Of course it's a well-known sales adage that time kills deals, but some contractors find that customers with bad credit are less time-sensitive. “They're not likely to cancel during the wait period because they know that they have problems and they understand how that has an impact on the process,” Hines says. However, everyone says that it's still important to get the buyer off the street as soon as possible. Simone says to figure that you have one shot at a primary lender and that you need to get them to a secondary lender as quickly as possible. If customers get impatient, he suggests keeping them engaged in planning the job. One way to do this is to send someone back to the house to review color sheets with the customer, or to confirm measurements.
GETTING IT RIGHT
You will get a financing decision much faster by getting the customer to the right lender in the first place. That starts with a good questionnaire. It should ask whether the customer has good, average, or bad credit, and whether they have been delinquent on their mortgage, credit cards, or car payment. And it should ask if there's anything else they want to tell you about. Says Simone: “You would expect people to lie, but most are more critical of their own credit. They don't want the embarrassment of being turned down.”
That raises an important point: If you want to keep this customer, you need to be careful not to make them lose face, so don't over-promise or set them up for disappointment. “No one wants to hear that they got declined for a loan, so if someone has a 550 credit score, we don't send them to a first-tier lender,” says Pat Pagano of American Siding and Windows Systems in Des Moines, Iowa, who estimates that 35% of his customers don't qualify for first-tier financing. “We tell them we will get the best deal possible based on their credit score and their home equity. We also quote monthly payments conservatively. If they have great credit, the actual payment will be lower than our quote and we will look like heroes. If they don't have good credit, the payment will be right where we quoted it. The worst thing you can do is to quote a low monthly payment and then find out that the payment is $40 per month more than you thought.”
One condition for approval is that the lender will likely discount the amount it pays the contractor by as much as 20%. On a $10,000 window job, for instance, the customer still has to pay back $10,000 plus interest, but the finance company will only pay the contractor $8,000. The reason, Simone says, is that lenders can predict roughly how many loans will default, based on their borrowers' credit histories, and they set their policies to compensate for those losses.
Because it's illegal to inflate prices for customers who have bad credit, the contractor needs to find some other way to recoup the discount. Pagano simply sets his prices higher. That may mean working with a gross profit margin that's close to 50% and accepting a certain percentage of discounts that lower it to 35%. “If I know that one out of four jobs will be discounted, then I need to put enough money into my pricing so that it's not going to hurt me.” He says that making this work means that his salespeople need to sell a job on monthly payments rather than price. If they know how to do that, the fact that his prices are higher than some of his competitors isn't a problem.
Editor's Note: Subprime home mortgages have been in the news recently, largely because of foreclosures in cases where adjustable interest rates reset and homeowners couldn't afford the higher payments. The home improvement finance instruments described in this article differ from subprime mortgages in two important ways: The loan amounts and monthly payments are much smaller, and the interest rates are fixed so payment amounts never change.