Insurance, property taxes, and cost of living all impact monthly expenses for homeowners, and in some cases dwarf the interest rate changes. But for many, giving up a guaranteed low mortgage payment is difficult financially and psychologically. Most lenders are focused on obtaining their share of the purchase market, but refis are still there. A number of STRATMOR clients are seeing “green shoots” in the refinance segment of the industry, and not only in home equity products. Understanding borrowers, and taking a look at their perspective and psychology, is important. Did the low mortgage interest rates of 2020 and 2021 spoil us for the years ahead?
An economy, including the housing market, is made up of individuals making individual choices. But in residential lending, individual rational choices, in aggregate, are causing a huge problem. Even if they didn’t buy, millions of homeowners refinanced during the low-rate years. By the Spring of 2022, over 90%of homeowners had a mortgage rate under 6%. Six in ten homeowners still have a mortgage below 4%, not to mention all the households that own their home outright with no mortgage rate. That said, as time goes by and prevailing rates are in the 7% range, should rates drop, these will be worthy refinance candidates.
Most people think of home loans falling into two categories: fixed-rate and adjustable-rate. But with some work, fixed-rate mortgages are actually adjustable, given the ready availability of refinancing options, but only in one direction: down. Traditionally borrowers refinance to lower their payments, so rate adjustments are almost exclusively downward. Usually when a buyer refinances their home loan, the new lender issues a new mortgage and pays off the original loan(s). The original lender receives back the principal to lend at 7%, instead of waiting for a 30-year mortgage to amortize at 3%. As with other voluntary transactions, traditionally all parties benefit.
Lenders and borrowers know that a low mortgage rate is highly desirable, and non-transferable in the United States for the majority of loan programs. Assumable mortgages in the United States are most often associated with the Federal Housing Administration (FHA), the Department of Veterans’ Affairs (VA) and some Department of Agriculture (USDA) loans. Most in our industry know that, by law, there’s no way to detach a certain loan from the property that serves as its collateral and reattach it to a new property.
The press has come up with the term “lock-in effect” since a low mortgage rate functions as an emotional and economic anchor. Homeowners are less likely to “step up the property ladder” (by selling or renting out their starter home for a larger one, or a more desirable school district), and also less likely to downsize and move on when their needs change. Both the supply (existing homes entering the market) and the demand (people searching for a new one) are suppressed by mortgage rate lock-in. This can cause property markets to stagnate and inventories to wallow.
Borrowers are faced with the prospect of the real cost of a higher rate, should they refinance, or the real cost of a higher rate, should they move. Either way, qualifying can be more difficult if wages have lagged. Na Zhao, economist with the National Association of Home Builders, found that a rise in prevailing mortgage rates of 100 basis points increases the annual income required to qualify for a loan by $10,000. Just one in five American families earns enough to qualify for median-priced homes at 7% interest rate, so homeowners facing those incentives are more likely to stay put.
When people aren’t moving, it impacts more than just the lending industry. Moving companies, recruiters, real estate agents, furniture stores … the list goes on, all the way up to impacting gross domestic product. As the property market locks up, labor mobility does, too. Though many jobs have gone remote, mortgage lock-in modulates the geographical allocation of labor and leads to a mismatch between workers and jobs, as some households forego higher-paid employment opportunities due to the financial cost of changing their mortgage situation. The favorable difference in pay or cost of living must be commensurately larger to entice someone to seize his or her potential by moving to a new city, or even across town.
As mentioned, many lenders are seeing refinancing occurring. But these aren’t the same refis as 2020-2021. The STRATMOR Group has done research on industry refi trends. In a recent article about the refinance landscape, Senior Partner Garth Graham shares that lenders who buy “trigger leads” will likely face competition from those who already service the borrower’s loan and know how to build and maintain a relationship. Servicers have “stepped up their game” when it comes to portfolio retention. STRATMOR has worked with larger IMBs who got into the servicing business specifically because they saw it as a source of future new business leads. Aggregators are aggressively soliciting for the refinance with a streamlined process, an easy escrow transfer, and perhaps lower rates and fees.
Capacity is no longer a problem, and lenders are waving the refi business in. About half of all new refinance loans (units) originated in the last six years have been through consumer direct shops. That number was only 40% in 2018 and 2019 (before the last boom) but is up to 54% now. The big CD lenders (mostly servicers) have the staff, marketing muscle, and have built out major “big data” or AI approaches to identify the most likely refinance candidates. In addition, consumer direct operations have different compensation structures that, at 40 basis points, are relatively low: Traditional comp plans are serious impediments to any lender who wants to be competitive.
Lenders who cling to the 100-basis-point for refis model will find it very difficult to compete with the big call centers, which pay dramatically lower compensation per loan. And they may find it hard to compete with banks that also pay less and have some ability to cross sell mortgages to their depository customers.
To help borrowers, lenders are doing their best to make sure that they’re in the right channels and tuning up their lead generation machines. STRATMOR is assisting companies in building a better, more streamlined process and in examining whether an overhaul of the compensation plan is needed.
Lenders are ready to help finance purchases or refi existing home loans, often to lower overall debt loads. But if people don’t move, either to bigger homes or to better jobs, economic mobility stagnates. Mortgage lock-in is just one example of the unintended consequences of past economic actions. The Fed is expected to take a break after cutting in December. Homeowners will continue to feel locked into their mortgages, and the broader economy will continue to feel the “strain” created by the low rates we saw in 2020 and 2021. Yet refis will continue to add volume to lending, and lenders must be ready for them.
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