Home improvement lending with fewer bankers and more computers

title: Home improvement lending with fewer bankers and more computers
author: Complex Systems with Patrick McKenzie (patio11)
contenttype: podcast
publication: Complex Systems with Patrick McKenzie (patio11)
published: 2025-10-30T07:01:00
sourceurl: https://pscrb.fm/rss/p/prfx.byspotify.com/e/media.transistor.fm/4b510c24/34ca9bdc.mp3

word_count: 5535

Welcome to Complex Systems, where we discuss the technical, organizational, and human factors underpinning why the world works the way it does. Hi, dearho, everybody. My name is Patrick McKenzie, better known as patio 11 on internet. I'm here in the studio today reading an issue about bits about money, which I wrote recently about my experience by buying windows and then discovering some of the financial infrastructure that has wrapped behind them. So originally published as a window into modern loan origination on October 10th, 2025. And as for this format, I will intersperses some commentary as we go through. The ultimate goal of financial plumbing is to enable commerce and the real economy. Consider the humble window. It is a fairly expensive, surprisingly high-tech manufactured good, installed by the dozens in homes by our distance. A window of represents a supply chain, and one part of that supply chain is a sales process, convincing a homeowner of the desirability of updating their windows. The sales representative running that process would urgently prefer to leave their single visits to the home, with not just tentative measurements, with a durable commitment to buying the window, and financing firmly in place for it. Why finance the purchase? Windows cost $1,000 to $3,000 each, and updating all or a large fraction of them quickly becomes the mid-five figures project. Relatively for you homeowners will pay upfront with cash. Moreover, the sales process would strongly prefer the purchase to be financeable, because that will sell more windows than a counter-factual world where windows were only available for cash. Side note, this is part of the original sales pitch for why you should pay money to accept credit cards. One could imagine a world in which window manufacturers or installers provided financing off their own balance sheets. That would be a rough world for them. They have upfront capital outlay, the window, and they could only recoup after extended periods, bearing credit risk all the while. No, they would prefer to sell windows for money. It's frequently delivered in milestone payments, perhaps half a prior to manufacturing the window, and half upon successful installation. Side note, also a reason why businesses paid for credit card payments. You could imagine the buyer bringing their own financing, perhaps by going to their usual bank and asking for a home improvement loan. That product very much exists, but it might be surprisingly less attractive to all parties. It will be costly, lower margin for the bank, and have poor operational dynamics for the window company. And so you could imagine the window company asking the financial industry to come up with an alternative. That alternative exists, and can underwrite and paperwork a four-party commercial loan in 15 minutes before the salesman has even left their home visit that sold the window. We'll return to it in a moment. Why not just have banks make a loan money for your home improvement? Again, very many banks do actually make home improvement loans available, but they're not wonderful loans for the banks. We'll begin with the somewhat awkward dollar amount. A home improvement loan is enough money to hurt if it goes bad, but not enough money to justify a high-volume well-oiled machine to underwrite them. Not like, for example, mortgages. And indeed, that is what many banks will immediately try to sell you if you ask for a loan for the purpose of home improvement. Can we instead counter-propose a home equity line of credit? He luck. You can then borrow against your existing home equity, withdrawing cash, and we have no objection to you swapping cash for a window. A decision we need here no more about. We have a supply chain for mortgages, including Helux, and this supply chain will decrease our capital requirements while smoothing out every part of underwriting. Why does the bank want to take the window out of the window purchase? Because a home improvement loan otherwise requires multiple operational intensive document reviews and conversations where bankers talk to construction company office managers. Those conversations are frequently unhappy ones. Consider the case where construction project flies off the rails, which has been known to happen. The window company says it is installed the windows, and potentially they have a certificate proving that they were indeed installed, allegedly signed by the homeowner or spouse on the date of installation. The homeowner, however, is unhappy with the windows. They're drafty. The colors are the same as the brochure. And goodness, was this what I agreed to pay $25,000 for? They don't want to pay it anymore. The bank must be the adult in this scenario to release that second milestone payment. They very possibly could be drawn into litigation over the decision because a few tens of thousands of dollars is just enough to justify calling a lawyer. Then the bank will have to have their own lawyers defend their own contracts and an expensive proposition over what is to it a small dollar loan. It's not nearly this hard to generate $25,000 of balances with a credit card issuing business. You mail out the cards and people buy your plane tickets. And then the airline patient 200 basis points off the top for the privilege, even before you get to originate the high interest loan. Great business to be in and you never have to talk about a stewardess spilling someone's drink or it raining in Hawaii that week. Meanwhile, the window installer has their own complaints about this loan, even before it is originated. Between the day the salesman shakes hands with the customer and the day the bank commits to the installation, the installer has very little they can do to influence success. The homeowner might develop buyers remorse and while they have signed a contract, it's just rough to compel payments for windows which don't exist yet. Your staff will not enjoy the process, your reviews will suffer, and it's not guarantee that your contract will hold up. In some states, your customer might even have the legal right to sever during a cooling off period. You would prefer to accelerate the delivery of windows to avoid the customer cooling off on the idea. But the bank is slow and has a bespoke underwriting process which requires information from you but wish you cannot control because the window installer is not the bank's customer. They can't call the bank up and yell at the underwriters to move faster and they can't debate the bank over a credit decision where a perfectly good sale gets next six weeks later because the bank just isn't feeling it. Very few of those sales will result in the buyer arranging successful alternative financing, partly for very human reasons, or a little burned out on the window sale right now, and partly for a mechanical one. The fact of the hard pull on the credit report for the loan origination plus the non issuance of a loan from one's home financial institution signals to the rest of the world, oh goodness, there are probably better ex ante risks in the economy than this one. No, what the window installer wants is a lending product which can be issued at scale very predictably in the short time frame is possible by financial institutions responsive to it who ask very few questions, always fund milestone payments properly and actually want this business that product do cysts. Modern installment loan origination as a service consumer credit issuance is unless it comes directly from a manufacturer, a privilege reserved by law for regulation. But as we've established, regular financial institutions don't lust for this business on their own balance sheets at scale. Recharacterizing the home improvement loan as a drawn a he locked allows the bank to quickly get it off their balance sheet because he locks will generally be securitized. You could theoretically securitize a large pool of installment loans if you had a business process to generate them, but unless the bank specializes, they are unlikely to have courted passitors simply ask for enough of the use every year to justify building out the framework. Why is it reserved by law for financial institutions as bits about money mentions often financial institutions are a policy arm and one thing the state requires is that compliance make sure that the financial institution is not abusing customers. The state believes that for example, a window installer might use high pressure sales tactics or say untrue things to a homeowner about how, for example, interest free financing periods work. And then perhaps forget about those things when the customer complains. It believes rationally that financial institutions will keep extensive records of what they communicate about loans. And those records will be truthful by default and that financial institution will not endanger its permission to do business over a single product. And this is a blunt but true observation, the state trust white collar employees and executives said banks more than a trust blue collar window installers or salesmen. So we need a bank involved but that bank does not necessarily need to lend out from its own balance sheet and rate. The bank could immediately sell a large portion of the loan retaining perhaps 1% for forms sake to a private provider of capital. But again, it is unlikely that a bank will want to call around hedge funds and see if there are any takers for a new $24,500 asset in the marketplace. Someone needs to have capital providers have a standing offer to snap at this product and quickly. That standing offer is very silly called a forward funds flow agreements or warehouse financing. I've previously discussed the mechanics of it for buy now pay later and they're the same here. Someone, typically a facilitator and not the bank itself, has brought the capital partners to the table, negotiated terms and has prepared them to receive what they want. Millions of dollars of loans at attractive prices with known in advance credit characteristics originated by a massively scalable process conducted partly by commissioned earning sales reps bearing iPads into houses needing windows and partly by web applications and operational teams. As an aside, in a fashion similar to how ad tech can conduct an instant auction for your attention when you are reading the New York Times. The facilitator that is bringing partners to the table is sometimes bringing partners that want different parts of the facilitator's business. So, some might want more loans made in Illinois versus loans made in Kentucky for their own various risk model or other operational dynamics reasons. Some might have different credit underwriting models than their competitors do. And of course pricing can be different on these things. And so the facilitator might be effectively bidding these against each other. I think the acknowledgement of an ad read sounds cooler in Japanese. Let me tell you a scary story. You work in marketing and are all set for the new campaign. Leadership loved the wireframes design produced in their usual tool chain and everyone is plus one for launch. Except your customers can't actually click on a wireframe. Engineering told you that no one ever gets promoted to staff engineer for just quote making websites and quote. And it's not quite what design envisioned. We've all been there unless you use Framer a sponsor of today's episode. Framer already built the fastest way to publish beautiful production ready websites and it's now redefining how we design for the web. With the recent launch of design pages a free canvas based design tool, Framer is more than a site builder. It's a true all-in-one design platform. From social assets to campaign visuals to vectors and icons all the way to a live site. Framer is where ITS go live start to finish. Framer is a free full feature design tool. Think unlimited projects, unlimited pages, unlimited collaborators and all the essentials. Vectors, 3D transforms, gradients, wireframes. Everything you need to design totally free. Ready to design, iterate and publish all-in-one tool. Start creating for free at framer.com slash design and use code complex systems for a free month of Framer Pro. That's framer.com slash design, promo code complex systems, all-in-word, all capital letters. Rules and restrictions may apply. This podcast is brought to you by Mercury. As many listeners are aware, I love a good bit of banking. I even enjoy the sucky frustrating bits of working with large banks because I'm broken. You know who isn't broken? Mercury, which offers business banking services to 200,000 companies, including mine. I've used them for business banking for more than six years and been quite happy for the duration. Everything happens in a well-designed website and mobile app. I use them for the debit card that pays for the studio rental for paying myself profits and for transferring money to contractors. I even use them for wires to angel investments, and I've never gone through and involved regular role over a single one. And, wouldn't you know it, most of those wires go to other Mercury customers. Mercury works well for businesses at a variety of stages and industries, from quickly growing funded startups to this relatively tiny internet publishing operation. Visit mercury.com to apply online in 10 minutes. Mercury is a financial technology company, not a bank. Banking services provided through Choice Financial Group, Color Manet, and Evolved Bank and Trust, members of FDIC. Back to the essay. This machinery wasn't originally perfected for windows. It was originally aimed mostly at solar installations, which were heavily taxed advantage at the time. Capturing the tax credit required a sale and upfront capital outlay. And the pitch was essentially, sign these loan docs for free money for all of us. And also, you'll get some solar panels. But the credits eventually expired. The addressable market for solar got more tapped. And the software and companies yearn for more originations. So, sign these documents, get windows at attractive prices. The loan application begins with the customer verbally informing the salesman of their phone number or email address. They then get given a link, which swiftly brings them to a competently designed web application. That application asks a few simple questions that are required for underwriting. The two most important ones that are not on a credit card application are, is this your house and to live in this house. That is because the capital partners are much, much more confident that people will not welch on debts tied to their primary residence. Then they are that every real estate investor will be above water if 2008 happens again. Questions about your finances are extremely pro forma. You'll be asked to self-state your income, but no attempt will be made to verify it. The credit report will be pulled, which satisfies the twin purposes of a, derisking the applicant pool, and b, verifying, via checking for the presence of a mortgage, that you do actually own the house. As an aside, you can see my essay on title insurance in the United States for the complexities of verifying at scale that Americans own houses they resided. When I actually tried to buy windows, I ended up in a fraud queue at this point in the process, story of my life. The facilitating company does not expose to the sales rep, why you are in the fraud queue, but the clock is ticking. And the rep will, hypothetically, strongly prefer continuing to drink tea and chitchat rather than leaving and letting one resolve that issue asynchronously. It was resolved by a combination of automated submission of a passport photo, again, shockingly competent software by the historical standards of loan origination and an annual list manually clicking a button in a web application. If I were to speculate what that analyst was doing, it would be reviewing the facts. The credit card report says a high credit score, the credit report shows a mortgage, credit report does not match this address, but a government provided IT does match the certain identity. And thus the wager is in his own house or has he is decided to pull a hilarious prank on a window installer and buy someone else windows with the hedge funds money. The analyst swiftly concluded I was probably in my own house. Why did I end up in the fraud queue? I have a lot of weirdness such as not being listed on the deed due to holding the title through a land trust for privacy reasons. Unfortunately, that sometimes makes it difficult for crime jobs to conclude I actually own the house I live in. Once you're approved for the loan, you are automatically sent to loan documents for signature. This will not be compelled at the signing, but the installer sure would appreciate you signing before they leave. Compliance is extensively briefed them on where the line is. Compliance has in fact extensively briefed them on many lines. And because compliance cares more about the law than it does about paying programmers to code a login form, I was able to read their entire compliance training series and presentations to installers. As an aside, I got an anonymous email after publishing this essay. Compliance is annoyed that people keep forgetting their logins, which that's speculatively sounds extremely likely to me. The contents of those presentations don't lie. Don't translate any loan docs from English or provide any gloss to the terms. Don't say any of the forbidden phrases like guaranteed approval. Same is cash financing, interest free financing, etc. And definitely, definitely do not touch their phone or computer during the application process. The financial industry learned some things during the global financial crisis about aggressive salesmanship by its agents. Almost every bullet point in that 40 page PowerPoint has a stack of criminal convictions, billions of dollars of losses or both justify it. What's the actual product offered? The salesman will first quote a scary number to anchor you, then present the discount available if you commit within a month. They will then say there is a sweet error, if and only if you sign before they leave. Compliance is very clear that if you stay in the context of acting as an Asian for a financial institution, it had better not be a lie. But percentages are percentages and window companies like making deals for windows, and I would not that against the proposition that there could be other inducements on other days for other reasons, perhaps something to similar numbers. Then the salesman presents the financing terms. I was pleasantly surprised that this was not presented in the typical obfuscating car dealer financing for a square method. If you've never been exposed to that, and I hope you never are in your life because it's terrible, that's the borders on lie way that people sell use cars in the United States. Trades off your trading value, the dealer financing, the purchase price, and one other factor, the mostly payment I think. The real price stays on screen at the iPad at all times. And you are presented with columns for choices, pay cash, which they mean immediately deliverable value, not actually physical currency, 12 month deferred interest financing, 15 year fixed rate financing, and paying milestones, for example, a 50% deposit and 50% due on installation on a credit card. Compliance will inform representatives that you are absolutely not supposed to use the words same as cash and interest free to describe 12 month deferred interest financing. This seller man is unfortunately a bit forgetful sometimes, so I cannot quite recall what the friendly local salesman actually said when pointing to the iPad. The offer is, if you pay fully for your windows within the next 12 months, you just pay the sticker price. If it takes longer than that, you will pay us interest starting from the date of installation at a rate which is materially higher than the rate we quote you in the next column. You might think that given this sketch, the system is trying to trick naive homeowners and surprise them on day 366 with a nasty bill. I'm slightly more sympathetic. This offers design to be attractive to people who can bring their own financing without making the installation dependent on that financing. If, for example, the customer does not currently have a HELOC, but is pretty sure they can get a HELOC. The window installer is saying, great, convince any bank to give you a HELOC, then do a draw anytime the next year and repay us and we'll put the interest until then. But to be clear, this window is going in irrespective of your future discussions with banks. Our capital partners do not want you to attempt to skate if your financing falls through, or if you get divorced, or if your tax refund is smaller than expected, etc. You will be penalized if you attempt to turn this into a backdoor installment loan. But the next column is where the real action is. I was quoted 6.99% APR for equal amortizing payments over 15 years. They naturally expressed the says monthly number, but the contract loudly and flooredly disclaims in bold print as required by regulations. The total interest cost over the life of the loan, the fact that there is no prepayment penalty, and etc. This is as honest as consumer lending can possibly be. You assign the loan documents and then the salesman thanks you for your time and arranges for another professional to come back and redundantly measure the windows. He measured for the quote, and the quote was good, but they'll measure again because a quarter inch matters a lot more in the physical universe than it does for the spreadsheet. Then the order goes to the factory and a few weeks later they install the windows, you sign an acknowledgement and then the automated software springs back into action, start in the clock on your interest and collecting payments. How does this pie get divvied up? Here I am going to speculate in reliance upon publicly available data sources rather than use the information which I know is a result of private commercial negotiations. See, windows salesmen are not the only professionals who have been to conflite training. In the 15 minute window, but don't bum, between the loan being applied for and signed, software has conducted a four-way commercial negotiation between the window installer, the facilitating entity, the bank, and the capital. The loan contract is between the customer and the bank. Again, it has to be regulations. But the capital provider is a specialist institution. There are a few banks which specialize in doing business slices. One of them is Cross River Bank, which keeps the keen eye and trends in consumer lending, and you can google either of those or see the links in the show notes. A bank which originates alone might charge of facilitating entity in upfront fee for services, and also collect a servicing fee from the capital providers, sliced out of the APR quoted to customer. And of course, it retains actual economic interest in the loan. Well, okay, it retains a few hundred dollars of the loan, so that it can tell its regulators, no, really, we are lending money here. It would be calamity to describe this situation as renting out a banking license. Indicatively, the fee for services to the facilitating entity might look something like 1% of total loan volume in a quarter. The servicing fee charged the capital provider might be 1% of the outstanding balance annually. More servicing fees are about 0.25%, but houses cost more than windows do for obvious reasons, and so you get an economy of scale here. The servicing is essentially the same amount of work. You need to 1-800-number lawyers on standby, the capability to receive checks, etc. So who is the capital provider and where are they getting? It will generally be a specialist fund, like say sunlight financial. Whose name alludes to the solar business they got started in. You might naively assume, okay, 6.99% to the customer, 1% servicing fees in the bank. So the capital provider gets 5.99% APR on the loan, right? I doubt that is the full calculation. One reason is that it sounds awfully cheap. The 10-year treasury rate is currently above 4%. So why would you give a consumer 15 years fixed rate financing for 6%, even with excellent credit quality. 2% spread doesn't sound like enough money to make a business out of this. But what if, like by now pay later, you could charge someone else a bit of money. Who benefits the most from this transaction being possible, the window installer. So charge them for it. They're clearly willing to pay something like 2.4% to the entire transaction already, because they will happily let you buy windows with a credit card. So that's the floor. A by now pay later provider can charge Sephora something like 6 to 8% to sell lip loss. So that's the ceiling. So can you get the window installer to kick in 5%, probably? That moves the APR as perceived by the lender to about 7.9%. Ask Python or Excel if you don't believe me. It's a bit better than this, too, because of what will happen to the fund if interest rates fall. The value of outstanding bonds increases if rates fall. But this consumer loan might get rolled into, for example, a new GP lock if rates fall. The free no penalty payment option is a fundamental challenge in mortgage finance. And here I would recommend, as always, Bernhardberg's masterwork. The 30-year mortgages is an intrinsically toxic product linked to it in the show notes. So by default, this is a lose-lose situation for the lender. If rates rise, the value of the loan falls. If rates fall, the loan very possibly gets repatriated. But with the origination fee from the installer, if rates fall and the loan is repatriated early, the return on capital over the lifetime of the loan rises sharply. If the loan is repatriated after 7 years, which is approximately the average 10-year in the house in the US, the real rate is about 8.15%. If it's extinguished after a year, perhaps due to rates related refinancing, about 12%. These numbers start sound attractive to credit funds, particularly when you have a repeatable process for generating them at nine figure scales with independent credit quality. I'll note, as an aside, a credit fund is making a lot of different bets, many of which are rates dependent. And so having a category of bet, which has a thing which moves in the opposite direction as rates, is a really, really nice attribute to be able to sell them. Similar selling at alpha like a hedge fund would sell to a pension manager. We don't expect that we're 100% of your investment assets, but for a 10% allocation, you know, you should put some money into us. As an additional wrinkle, is sunlight the ultimate source of capital at risk? Well, if I were sunlight, I might think of tapping the booming private credit market, borrowing at a lower rate than I earned an expectation on my portfolio, and collect the spread. If I were Apollo, such a natural brand to associate with sunlight, and among the world's largest credit funds, I might buy an insurer, or figure out how to get retail's private credit exposure, to fund billions of dollars, to anyone who creates a loan origination engine with demonstrable credit quality. For much more on that side of things, you should read money stuff, or listen to odd lots, which both cover private credit is the new bank lending all the time. I'm just presenting the speculative case for how private credit runs permanent capital vehicles into windows. Is this unsecured lending? Compliance will tell you not to describe this as unsecured lending to the customer. I am so forgetful as to often to comments made during sales presentations, though. Formerly, the lender does have a security interest. However, they do not want to go to the trouble of dirtying the title by getting a lien on the house. That can't be done in 15 minutes. No, they only have a security interest in the window that they have financed. A security interest in a car is valuable, because people are quite attached to their cars, and if push comes to shove, you can repossess a car. A security interest in a house is valuable, because people are quite attached to their homes. And if push comes to shove, you can foreclose on a mortgage and repossess the home. A security interest in a window is valuable because... Actually, a security interest in a window is not actually that valuable. However, by construction, the commanding majority of borrowers will have excellent credit. One factor decreasing their credit risk is that many consumers are, this is an underwriting term of art, judgment proof. If you sue them for performance and a court gives you a judgment, that is worth the paper it's printed on, because they might not have easily attachable assets, and they might have employment in a system-D kind of fashion, where garnishing their income is difficult. A homeowner, on the other hand, always has one asset you can attach, the home. By finally moving on it, after receiving the judgment. A lien against a house is an immediately monetizable asset in much of the United States, because it blocks the sale of the house until it is satisfied. There exists a specialized financial ecosystem, which is happy to buy that lien, and then attempt collection by some combination of A, asking nicely, and then B, in the alternative, waiting patiently. And so the lender's contract is, to the extent that it is concerned with credit risk, concerned with swiftly demonstrating to a court. Here's a valid contract, the loan paid for Windows, the customer isn't paying. Please issue a judgment. Thank you very much. We'd like to file a judgment as lien coincidentally against the same house. It's only fair. Should we be happy this group Goldberg machine exists? Nice new Windows are better than broken ones, and the process of buying them is now painless at an attractive financing cost. They are still expensive, but homes are expensive. Every time someone mentions innovation and consumer lending, the same comment is made. Isn't this just the financial crisis all over again? Well, congratulations for watching the big short. Are we stacking billions of dollars of low-quality loans with intermeeting layers of complex products like CDO squared? Isn't this going to blow up? That's an understandable point of view. But there is an actual underwriting process here. We've replaced you write a lion paper, and no one will read it, with a computer program that never gets bored at comparing databases. The borrower is actually reasonably good credit quality, rather than a ninja. No income, no job, no assets. One of the some-prived lending era excesses was writing ninja loans in quantity. I'll say as an aside, ninja is often misunderstood by people whose education this came from the big short to mean that someone has no income, no job, and no assets. What it really meant was there was no documented income job or assets in the credit file. That doesn't necessarily mean they didn't have it. But on a risk-adjusted basis, you would prefer to have documented income job and assets in the credit file than not having income job and assets in the credit file. This is just making bets in the fashion that insurance company would make bets. If the installer successfully leans on the origination machine to lower underwriting standards and let anyone who can fog a window by one with a smile, then the losses are largely not in the regulated banking sector. They're not backstoppable by taxpayers. They're mostly two sophisticated investors and credit funds were being paid handsomely to take that risk. The system is also self-correcting. Early defaults would cost the credit funds to tighten the risk appetites and constrain the original nations fairly quickly, rather than encouraging refinancing to choose the original numbers. Until we are all holding the movie margin call, the biggest bag of odorous excrement ever assembled in the history of capitalism. Besides, the credit quality keeps you up at night, you should be much more concerned about bog standard commercial real estate loans. That's all I have for you, and see you next week on Complex Systems. Thanks for tuning in to this week's episode of Complex Systems. If you'd have comments, drop me an email or hit me up at patio 11 on Twitter. Ratings and reviews are the lightblood of new podcasts for SEO reasons, and also because they let me know what you like.