This year’s resurgence of home equity shows no signs of abating as mortgage rates continue to climb. Total originations are up close to 50% year-over-year and the outlook so far is positive for 2023.
U.S. lenders are stepping up to meet the demand. The latest Curinos data show that cycle times (the point from application to disbursement of funds) now average 58 days, down from a peak of 80 days in January. That’s good news for customers who are eager to pull equity from their homes for improvements and large purchases.
Home equity lenders should expect the resurgence to continue amid strong consumer spending, positive momentum in home prices and expectations that 30-year mortgage rates will remain above the 4.5% mark throughout 2023.
And there’s a new wrinkle: the St. Louis Fed recently reported that the U.S. personal savings rate now stands at a 13-year low of 5.0% due to declining levels of disposable income for consumers. That could mean people who feel financially strapped may decide to tap into equity, further boosting usage.
Curinos recently outlined the opportunities for lenders during this home equity boom, but now it’s time to dig into ways that lenders can optimize the value of the portfolio.
Target High-Value Relationship Customers
We previously discussed the need to enhance front-line sales strategies that target day-one balance growth. We also examined utilization strategies to help drive net interest income. These tactics focus on product profitability. Depending on how a bank manages profitability, these strategies are highly appropriate.
There are opportunities, however, to create even higher-performing portfolios by focusing on a customeru2019s total relationship that takes all variables into consideration, including risk balancing, utilization expectancy and net interest margin. This is particularly relevant because most home equity customers often already have a relationship with the bank. These variables can be, and often are, leveraged independently by lenders. The process of identifying a target customer who checks all the boxes can help the entire organization achieve higher lifetime value, not just certain segments.
Figure 1: 2021-22 Vintage: Origination Distribution
Align Risk And Reward
The basic fact is that everyone targets the most creditworthy customers, but there is value in expanding the buy box by using relationship data analytics to assess potential customers. There’s no question that lenders understand the risks associated with home lending. Most lenders incorporate basic risk-based pricing and risk tolerance within their origination strategies at the forefront to help mitigate their overall exposure to higher delinquencies and losses. Identifying the desired reward or outcome, however, can help establish the risk tolerance needed to achieve the desired outcome. For example, every lender’s goal is to minimize high delinquency rates, combined with optimal balance and utilization percentages. But most lenders focus their origination strategies on super-prime, high-credit customers, which results in sub-optimal portfolio utilization. (See Figure 1.) In fact, super-prime credit customers tend to have the lowest utilization levels in the portfolio. A more balanced risk segmentation will allow lenders to retain their overall risk tolerance, while also attracting a more diverse customer base that allows for higher-balance and utilization segments that ultimately help achieve the expected reward.
Set Appropriate Limits For Borrowers
We previously discussed how sales strategies that focus on extending high credit lines (even if the borrower doesn’t need it) tend to result in low utilization and higher capital expense costs for lenders. (See Figure 2.) More than 80% of open HELOCs sitting in portfolios have a line size that excessively exceeds the borrower’s actual drawn balance. Although this may drive short-term origination growth, it creates expense challenges from capital charges on the unused portion of the borrower’s credit-line, not to mention sub-optimal utilization performance across the entire portfolio.
Traditional lenders may want to take a page from the fintech playbook, where new players are once again stepping up to address a longstanding industry challenge. Many fintechs that are relatively new to home equity are offering borrowers a conventional HELOC product that requires a fully-funded draw at the time of closing, mirroring the repayment qualities of a home equity installment loan. This new approach helps lenders eliminate unnecessary and excessive credit lines, while minimizing the impact of capital charges on unused line amounts.
Prioritize The Pipeline
Home equity operations are a touchy subject among lenders. While the industry has improved cycle times by more than 10 calendar days in 2022, total cycle times still hover above 60 days at many lenders. One way in which lenders can gain some efficiencies in the origination processes is to prioritize the active home equity application pipeline based upon customer retention and likelihood to draw. One such example is applicants who have a high propensity or known need to take an immediate draw for a debt payoff or consolidation. It may make sense to move these customers to the front of the line, ahead of others who may have less of an immediate need. Similarly, a decision to streamline a relationship customer’s refinance application should be deemed as a means of retention strategy while also prioritizing and optimizing the pipeline.
Figure 2: Despite its resurgence, home equity still creates challenges for lenders.
Strategic Portfolio Management
The importance of sound portfolio management can’t be underestimated. While day-one utilization performance is key for today’s origination strategies, a simple yet proven strategy to stimulate utilization on existing portfolios is through balance-build campaigns. For many lenders, these are simply reminders to non- or under-utilized HELOC customers that they have a credit line available for an immediate draw. Some lenders will even go as far as sending immediate access checks to existing HELOC customers to help incentivize line usage. Other lenders are launching e-mail campaigns to existing HELOC customers suggesting immediate cash access through their retail online-banking portal with a cash transfer to their check or savings accounts.
And what about a personalized message that highlights the uses for the line? We have noticed that you aren’t using your home equity line. Here are some ways in which it can be used can be an effective reminder.
The home equity market has seemingly shifted this year in a way that benefits traditional lenders, but anticipating what may be next for origination and portfolio management strategies always seems more challenging and, at times, unclear. With little sign that this resurgence will slow, it will be crucial for lenders to understand the market, target customers and set realistic
financial results.
