Susan Naftulin is President and Co-Founder of Rehab Financial Group, LP a private lender in the Philadelphia area.
Private lending can pioneer inclusive lending by being better at servicing the entire real estate investment community. Where do you start as a starting investor? Why would the industry close the door to someone who could potentially become a seasoned investor and repeat customer? More importantly, what does a more financially inclusive approach to lending look like?
The current underwriting processes of many lenders are very mechanical, like a robotic assembly line. In many cases they are automated. The process is aimed at scaling up and processing as many customers as possible as quickly as possible. While this isn’t necessarily bad for the average customer, it doesn’t efficiently evaluate a potential borrower who doesn’t fully fall within the lending box. It is not intended to ask questions of an individual investor, whether for information about their business goals or to assess their knowledge of the local real estate market. Of course, certain standards have to be met, but there is a wide area outside those standards through which a borrower qualifies for a loan, but that would not be apparent from a mechanical assessment.
Therefore, the focus of lenders should be on a 360 degree view of each potential borrower. That means making an effort to gather enough information for a fully informed decision that will create more reasons to say ‘yes’ rather than a mechanical ‘no’.
The mortgage industry has an unfortunate history of foreclosure and bias. Redlining – refusing loans from borrowers because of discrimination based on race, color, religion, etc. – is prohibited by the Fair Housing Act. However, there is a more subtle form of bias in lender decision-making these days, especially when it comes to looking at zip codes in mortgage applications. While redlining prohibits the complete elimination of certain zip codes to qualify for loans, zip codes are still used to determine pricing trends. This indirectly leads to credit decisions being made on a basis other than the borrower’s qualifications and the value of the collateral itself.
These decisions may seem understandable as they are based on financial risk and perceived or economic statistics, but they exclude many potential investors from getting into the real estate game. Without the ability to invest, certain zip codes will forever remain underexposed by the lending industry. It’s a vicious circle: the area cannot be improved because new investors cannot get loans to improve the area.
There is no company that wants fewer customers or a smaller group of people than it already does. As often as is practical, private lenders should cast as wide a net as possible. Inclusive lending looks at the potential of a new borrower or an experienced borrower moving to a new area. Deprived communities are often a perfect way for a new investor to start investing in real estate, as prices are generally lower than in more developed neighborhoods.
Inclusive lending does not require a redesign of the underwriting process, but rather requires a much more human and personal approach than many private lenders were willing to take. A zip code restriction eliminates some excellent communities and up-and-coming neighborhoods. Just looking at the average value of real estate, rather than the local investment opportunities, eliminates the potential that investments can bring.
Good real estate investor products and underwriting practices need to go beyond the proverbial three Cs (credit, collateral and ability to pay). The mechanical, robotic way of evaluating a potential borrower ignores something about the applicant that should always be considered. Underwriting should really focus on all aspects of whether the borrower has the financial means, resources and capabilities to qualify for the loan by using an additional C. The fourth C is character.
When looking at a borrower’s character, we need to step back to observe the overall picture of the borrower’s stability, reputation and vision for a real estate investment. The fourth C may include factors such as the stakeholders or other investors involved; the business plan; whether the property is rented or refurbished, marketed and then sold to someone else; whether the property can be refinanced over a 30-year period; and the foresight of who is the “take-out” lender they’ve already hired. These qualitative details tell a much bigger and clearer story than just the original three C’s alone.
Viewing each borrower as an individual with their own unique circumstances, and taking the time to really connect with them by asking qualitative questions at a human level will always yield better results than a standardized algorithm or formula. If the underwriting decision could be confidently influenced by more discovery in this way, private lenders everywhere would make better credit decisions, be even more inclusive, and ultimately be more successful than they are today.
It is often easier for lenders to say no. Not every lender can and should be everything to every borrower. However, in a world of inequality, it is the lending industry’s responsibility to create as level a playing field as possible. In a country with a housing crisis exacerbated by institutional investors, whose infinite resources will beat the individual homebuyer and investor almost every time, it is the duty of private lenders to make more housing available to as many people as possible. It’s about attracting more people, taking out more loans and achieving more business success, not less.