Really, We're All in the Same Boat?

To be honest, many times issues are presented in grandiose terms, but only impact a specific segment of the industry. Sure everything is ever so slightly tied together the further you pull back from the trees to the forest to the 30,000 foot view. But let’s stay low on the issues presented. In fact, zoom all the way in on your GoogleMaps as close in as you can get, and I’ll tell you why what you just zoomed in on is our little boat.

A common first reaction regarding this CFPB “stuff” is to think, “Oh, that’s a finance company’s problem.” And I’ll agree it is also their problem, but they are not alone.

Let’s talk about the “big boys.” Sure we all know who they are. We know the market share they each have, and if you do any business with them at all, then you know what types of deals they finance. Some of the “big boys” have a tremendous amount of their current market at stake. Higher points, fees and interest rates are needed to make lending profitable (unsubsidized lending specifically) in the market of low-balance loans with riskier borrowers.

Other lenders only play in markets with less risky borrowers. However, even for these lenders who write loans for higher-credit buyers, a massive constriction in the markets of smaller loans, greater credit risk and used home consumers will quickly impact their ability to obtain their higher-credit borrowers. These other market areas support the day-to-day operations of many retailers and therefore factories. If retailers cannot maintain profitability and go out of business due to a market constriction, factories close due to less demand. A constriction in these markets results in a smaller industry presence. The better borrowers don’t know where to shop or what they can buy because they can’t find a retailer open or a factory working to fill any orders.

For our factory readers the size of the impact is simple. Current low priced model sales sharply decline. Orders overall decline as both lenders change their criteria, and private money investors exit the space fearful of increased compliance cost and liability. The substantially fewer homes eventually built in reaction to the changes are built smaller and smaller, with only basic amenities, limited upgrades and lower margins.

Retailers and salespeople will feel the effects first and hardest. First, if lending is further constricted you sell less - immediately. Second, if SAFE Act is changed in an adverse way you are looking at more licensing, increased operating costs, limitations on sales methods, prohibitions on certain advertizing, and increased liability. The ability to purchase used homes in particular will be dramatically impacted for all non-cash buyers.

If you are a small community and you primarily rent lots with perhaps a handful of owner-financed sales each year, at stake is your ability to continue to do this limited owner-financed business. Current exceptions allowing minimal amounts of low volume owner-financing could change requiring licensing and expensive lending compliance.

Finally, if you are a larger community doing higher volume financing, or you sell a portion of your homes each year based on arrangements with other private money lending sources, you could face tremendous increases in costs and liability. Many people who currently operate in this industry segment dismiss the idea their business model could be impacted. Some will dismiss these issues because they currently don’t charge points and fees over the discussed levels. Others will dismiss these threats because they don’t need to charge as high of interest because the community business model allows them to more closely monitor their collateral and provides the added benefit of being able to offset origination costs and default risk with lot rent.

However, these lenders, whether they know it yet or not, are in the same market and thus have the same regulatory requirements as “the big boys.” The risk of not operating within compliance comes down to two factors – regulatory presence and civil liability. There is current uncertainty as to the level of regulatory focus (state, federal or combined) on our market segment. Similarly, it is unknown what the impact will be from possible disgruntled consumer civil law suits. Quantifying or definitively knowing exactly the level of risk is too difficult to predict. We will only learn after the passage of time and observing some “canaries in the coal mine” the true impact of coming changes.

There is potentially another area of risk for non-compliant operators – unfair competition. The risk is this: an operator bites the bullet, shells out the expense and becomes compliant either in-house or through third-parties. However, his down-the-street competitor decides he is not going to be compliant. After the compliant operator’s fourth lost sale to his non-compliant competitor who is price undercutting him due to his substantially lower overhead costs, it isn’t unreasonable to think the compliant operator starts looking at the anonymous complaint form on CFPB’s home page.

Once faced with full in-house compliance or going through a third-party, everyone will become acutely aware of the cost of origination. I have spoken to many people involved in the financing aspects of our industry over the past several months. The estimates for origination costs range from $750 - $2,500 per loan, depending on the lending platform, funding rate and other variables. If, for example, a fixed cost to originate under all of the new rules is $1,500 per loan and you are trying to make a $15,000 loan to a borrower, you now have 10 percent in points and fees. If you are limited to a range of 3 – 5 percent, you cannot afford to make the loan, especially when you cannot charge high enough interest to offset the loss at origination.

Finally, if our industry is forced to have traditional site-built appraisals based on an interior inspection and comparable real property sales data, lending as we currently know it will cease to exist. How many of us can survive in a cash only industry?

When I say our “small boat” this is in comparison to our formidable and daunting surroundings. But as you can see, our small boat is crammed full with all of us.