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Home Lending: How To Best Position For A Bounce-Back

It’s hardly news that residential lending is currently hamstrung by high interest rates and diminished supply. According to data from CurinosLendersBenchmark Analyzer, the average funded rate in April 2024 was 370 bp higher than in April 2021 (Figure 1). This has helped drive mortgage demand down 78% from 2021’s peak levels. For the same period, the purchase market is off 42% 

Figure 1: Purchase Volume Across Market Average Rate

With rates still stubbornly high, mortgage demand remains anemic. ​
Source: First Mortgage LendersBenchmark

Fortunately, these challenging conditions are expected to be followed by a phase of improved supply or lower rates or, in an optimistic scenario, both. But until this transition kicks in, lenders will need to operate within the confines of the prevailing cycle For many of them, that means diversifying their product offerings to better cater to evolving demand and to mitigate the trials of a contracted market. 

First-time homebuyers, for example, account for more than a third of all production year to date, compared to only 13% in 2016 (Figure 2), so it’s becoming increasingly imperative to offer products and other considerations tailored to their needs. These typically feature low down-payment requirements, relaxed credit-score criteria and educational resources to guide buyers through the intricacies of home purchase and ownership. Such tailoring allows lenders to appeal to buyers who might lack the means or otherwise hesitate to move toward homeownership. 

Figure 2: First-Time Home Buyers as % of Market​

With newcomers representing a rapidly growing segment of the housing market, ​
banking institutions should focus more on their specific needs.​
Source: First Mortgage LendersBenchmark

The importance of down-payment assistance is also growing, in large part due to the upswing in first-time buyers, but also because of persistently rising home prices. Such programs, which can take the form of grants, loans or matched savings initiatives, help with the upfront purchase costs. In addition to home affordability, amplified by higher rates and rising home values, lenders must also address other headwinds faced by borrowers, including those with non-traditional income sources – not tied to W-2s, for example – and limited credit histories. Taken together, these considerations could not only bolster homeownership among historically marginalized demographic groups, they could also parry heightened regulatory oversight.  

Finally, non-qualified mortgage (Non-QM) programs hold considerable potential. They provide loan access to prospective borrowers who might not qualify for a mortgage because of non-traditional income sources or limited credit histories but who exhibit robust credit profiles and repayment capacity. As with most other products, Non-QMs can either be retained within an institution’s portfolio or sold into the secondary market.  

Banking On Home Equity

Stubbornly high interest rates (even despite an impending softening) have made refinancing opportunities a thing of the past for most existing homeowners because their mortgage rate is already much lower than prevailing rates. But what’s bad for refinancing can often be good for home-equity lending. Products that facilitate equity tapping, such as home-equity lines of credit (HELOC) and home-equity installment loans, are poised to remain the preferred choice of equity-rich borrowers. 

In the first quarter of 2024, U.S. homeowners collectively saw a 10% increase in equity compared to a year earlier, according to St. Louis Fed data – nearly a $3 trillion gain (Figure 3). According to figures from CoreLogic, the average borrower is now sitting on nearly $305,000 in available equity. And because home inventory levels are likely to remain suppressed, most homeowners are likely to stay put for the foreseeable future, which will favor home renovation projects over relocation. 

Figure 3: U.S. Homeowner Equity (In $ Trillions)​

The recent surge in property values means that the average
homeowner is now sitting on about $305k in available equity.​
Source: Federal Reserve Bank of St. Louis​

This scenario bodes well for all home-equity lenders, but those that have surged onto the scene in recent years (particularly non-banks and fintechs) face a major hurdle. Although the demand for home-equity products is expected to increase, today’s sluggish secondary market for home-equity assets limits a lender’s origination capacity and ability to grow to a larger scale. But relief to the demand scarcity for securitized home-equity originations may be at hand. Freddie Mac appears ready to seek regulatory approval to support second-lien, home-equity term loans. If this occurs, it would significantly alter the secondary market for home equity by opening up additional securitization channels to lenders and enticing other securitization firms to enter the market. 

But even putting aside how much the securitization market’s appetite may grow, home-equity lenders have reason to be optimistic about the outlook for product demand. A sustained high-rate environment continues to make the financing rates and features of their products far more attractive than alternatives such as credit cards and personal loans.  

Still, it’s essential to recognize that an uptick in home-equity demand won’t address the housing market’s underlying malaise. Because most equity tapping is used for home improvement, existing homeowners may be inclined to stay where they are even longer, further exacerbating the inventory shortage. And home renovations invariably improve home values, compounding the affordability challenges for first-time buyers. 

While there’s a lull in demand that probably won’t last, now’s the time for home-equity lenders to act. They have a window of opportunity to align their products, fees and pricing strategies in anticipation of a surge in mortgage demand as rates retreat from their current levels – doing so stands to better position them in this increasingly competitive market.  

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