How to Survive this Cycle

How to adapt your Mortgage Lending to this new cycle

Recessions and booms are part of our economy’s Financial Cycles and are nothing new. When I entered the Mortgage Banking industry in 1985, it was with a Saving & Loan or S&L. The country was dealing with severe inflation and Mortgage Interest rates in the mid to high teens. “This produced two problems for S&Ls, says Kenneth J. Robinson of the Federal Reserve Bank of Dallas. First, the interest rates that they could pay on deposits were set by the federal government and were substantially below what could be earned elsewhere, leading savers to withdraw their funds. Second, S&Ls primarily made long-term fixed-rate mortgages. When interest rates rose, these mortgages lost a considerable amount of value, which essentially wiped out the S&L industry’s net worth”. The government moved to deregulate, but it was too late for the S&Ls. Nealy 750 S&Ls would be closed by 1995 at a cost to the taxpayers of $124 billion. “This banking crisis also resulted in major reform legislation that paved the way for a period of stability and profitability…until 2008”. *

The current economic climate is uncharted territory to many in the industry today. Low, stable interest rates and low inflation have been the norm for many years, but as you can see, this is not something new. With the Federal Reserve indicating that they will continue aggressively increasing rates to curb inflation, what will happen to Mortgage rates, how will buyers qualify, and how will the industry make ends meet?

Rising interest rates have caused the first lien refinance market to fall off a cliff figuratively. Still, with home values remaining at record high levels, Home Equity Loans and Home Equity Lines of Credit (HELOC) have seen a sharp increase. But will this last?

There are many factors to consider:

New Construction – Home builders have not been able to build fast enough to keep up with demand; however, as interest rates continue to increase, fewer buyers will be able to qualify or may choose to stay put where they are rather than buy.

Foreclosures/REO – Since the moratorium has been lifted, foreclosure rates have increased. REOs will follow, which will increase the supply

Interest Rates – Rates are likely to continue to increase, causing borrowers to qualify for lower loan amounts

Loan Products - Loan products have been very vanilla for quite some time, but as rates go up, this will change

Inflation – This impacts every area of life, including rent; however, the industry can leverage this to encourage home buying

Let’s break down what this will look like and how the industry will react

As interest rates rise, the buyer’s market will cool down and allow builders to catch up with increasing inventory. At the same time, foreclosures will increase, and REOs will hit the market, further expanding inventory

Buyers may back out of sales agreements due to the rate increase. This activity has already escalated to the highest level since early 2020, according to July 2022 reports from Redfin and Mortgage News Daily. **

To offset the reduced demand and help more borrowers qualify as interest rates continue to increase, alternative mortgage products from the past will emerge (this has already started). e.g., 10/1, 7/1, 5/1, 3/1 Adjustable-Rate Mortgages (ARMs), Buydowns, and maybe even Graduated Payment Mortgages (GPMs)

Buying is still more desirable than renting. Mortgage interest and property taxes are still allowed as a deduction for tax purposes. Home buyers effectively lower their taxable income; for many, a home becomes a forced savings account as they build equity. 

What should Lenders be doing right now to weather this latest economic storm?

1. Look for ways to improve operational efficiency. No matter how efficient they start, mature processes inevitably accumulate redundancies, manual tasks, and workarounds which rob efficiency. An objective analysis by a third party can be highly beneficial and help restore lost efficiencies.
2. Look for and inquire about new/old products like ARMs and Buydowns to help borrowers qualify.
3. Educate your production staff on how to extol the benefits of Homeownership vs. Renting in this higher interest rate and inflationary environment.
4. Consider outsourcing a portion of your fulfillment. Outsourcing gives flexibility when production moves without having to hire or fire staff and can reduce your overhead
5. Invest in technology that will improve efficiency. e.g., repetitive tasks and certain processes can be automated through technology, reducing manual input and improving accuracy.

Taking steps to improve how loans are generated, processed, and closed now, can help ensure your company is here for the next cycle.

*Source: Kenneth J. Robinson, Federal Reserve Bank of Dallas

** Source: Redfin & Mortgage News Daily July 11, 2022 reports