Rising rates, digitization, and limited inventory affect mortgage biz

For much of the past five years, this housing boom has closely resembled that of the last housing boom. There is strong buying activity amid rising prices with pockets of bidding wars breaking out in some markets. The economy is on solid footing; unemployment rates are low. What could go wrong?

Everyone remembers how the last run ended: Banks were soon busier working through foreclosures than booking new business, and the economy went into a prolonged and painful tailspin.

What about this go-round? Are we doomed to repeat history? Or will this time be different?

Although many parallels exist between now and then, differences outnumber similarities. Other factors have also emerged over the past decade that weren’t in place in the early 2000s, including millennial participation in home buying, and the rise of paperless, or digital, mortgages.

The appeal of ‘vanilla’

Bankers and others feel cautiously optimistic that the current run still has legs, and that another Great Recession-esque collapse is unlikely. But memories of that epic plunge and economic contraction are very much fresh in their memories.

Dan Vessely

“I think the big difference is that in 2004-2008, you had a lot of subprime or poor loans being done,” said Dan Vessely, president of the Iowa Bankers Mortgage Corporation. “The market was inundated with a lot of loans that probably shouldn’t have been made. When the financial crisis happened and when the market collapsed, you had a lot of bad collateral on the books. The difference is today you don’t have that.”

Indeed, several bankers noted that among the key differences in this market are much stouter lending standards than during the heydays of the last boom.

“If you look at it relative to where we were in ’06, we’re so much tighter,” said Joel Kan, associate vice president of industry surveys and forecasts at the Mortgage Bankers Association. “Underwriting is a lot different than it was back then.”

Kan pointed to products such as Alt-Doc and negative amortization loans that are far less prevalent now as demand has shifted to traditional “plain vanilla,” 30-year, fixed-rate mortgages.

However, while standards are tighter now, several bankers noted a loosening trend, and their opinions on its benefits were divided.

“We went through a period of time and what usually happens is the pendulum swings too far and you get some kickback, especially from the banking community,” Vessely said. A natural tightening that took place after the crisis was fortified by the Dodd-Frank Act. “I will say in the recent year or two I’ve seen them loosen a little bit, nothing of concern, but just some loosening and more common-sense lending that’s being done.”

Banks have been more flexible with lending standards as well as lending rates to draw from the narrowing pool of available borrowers as home prices rise, interest rates tilt upward and home buying slows. Motivated by a push to grow earnings now that they are on more stable financial footing, banks are looking to expand loan portfolios. Despite the market’s strength and still relatively low interest rates, MBA data shows total mortgage activity is half what it was during the run-up to the crisis.

Bernie Gaytko

“That has created some competition out there, and probably banks are sharpening pencils on deals more than they have in the past to keep their good customers,” said Bernie Gaytko, president and CEO of First National Bank of Waseca, Minn. “Sometimes we’ll shake our heads on some of the deals that some of the customers are saying they can get somewhere else.”

And while interest rates remain near historic lows, an upward trend is forcing buyers to adjust their expectations as they shop around. The going rate for a 30-year fixed-rate mortgage averaged 4.81 percent on Nov. 21 amid a steady climb over the past year, according to Freddie Mac.

Refinance activity that surged in 2013 has plummeted as interest rates have climbed. Refi applications reached an 18-year low in November, according to the MBA. Refis were about 75 percent of Iowa banks’ business between 2011 and 2015, Vessely said. They’ve fallen to 25 to 30 percent this year, a figure he expects to hold steady into 2019.

“That segment is down significantly from what it had been, and probably isn’t likely to be as much a part of our business going forward as rates continue to gradually rise,” said Paul Means, CEO at RiverWood Bank in Baxter, Minn.

While rising rates have made homeowners who bought when they were at historic lows reluctant to give up their sub-4 percent mortgages, they’ve also pushed some buyers off the fence.

“They’re going to be able to afford less house,” Vessely said. “I do think it will have a negative effect in that regard.”

A return of adjustable-rate mortgages could be on the horizon in the rising-rate environment as homeowners aim to sell prior to when the rate resets. After averaging as much as 32 percent of mortgage applications in 2004, MBA data shows that ARMs contributed just 7 percent of mortgage activity this fall.

Bankers said another key difference in this market is a tighter housing supply compared with the early 2000s.

A six-month supply of houses is generally held as a healthy balance of supply and demand. Supplies have generally hovered around the five-month level since 2013. The supply has since climbed steadily through the summer to reach 7.4 months in October.

New homes bucked that trend and remained in strongest demand, and were on the market for a scant 2.7 months in October, according to U.S. Census Bureau data — a record low dating back to 1975.

Tight supplies drove the median sales price of houses sold in the United States to an all-time high of $337,900 in the fourth quarter of 2017, Census data shows, far surpassing the previous boom’s high-water mark in 2007 of $257,400. In the Midwest, the median sales price settled at $292,100 in the third quarter of 2018, $3,300 below its record.

“This is a very different market in the sense that you have such a big difference in what supply looks like,” said Kan. “In the mid-2000s there was an oversupply of homes and building was still going at a pretty rapid pace. There was much more of a bubble risk then than there is now.”

The home-building pace lags that of the previous boom when housing starts often exceeded a seasonally adjusted annual rate of 2 million. Census data from October puts the seasonally adjusted annual rate for housing starts in 2018 at 1.2 million.

Paul Means

Means said builders and developers in northern Minnesota, who are still in the business after being burned in the crisis, have largely been conservative with their decision-making. Despite that, the volume of new construction, which had until recently been subdued, has gained steam.

Means said 2018 was the best year he’s experienced in new construction in his area since the 2007-08 timeframe. Homes priced in the lower half of the market have been in the tightest supply, especially in new construction; high-end stock is ample.

“It seems like in Iowa, a lot of first-time home buyers are looking at a price in that $200,000-$250,000 range, and you just can’t find it in new construction,” Vessely added, a comment echoed by many of his peers. “You can find it in existing homes, but it seems like every time you have new construction, the price tag just jumps into the $400,000-plus range.”

A major difference between this run and the earlier boom has been millennials stepping off the sidelines and into the market. While much of this group of 18- to 36-year-olds were too young to take part in the previous run-up, they have mostly been content to rent in major urban markets. However, they make up the largest national demographic – surpassing baby boomers – and represent a large pool of potential buyers.

As millennials shop for homes, they carry with them the experience of having witnessed how other homeowners navigated the boom and subsequent crash a decade ago.

“There are a lot of people getting into homes today, and they saw what happened to others during the downturn,” said Means. “A lesson learned, so to speak.”

Paperless mortgages

A potential differentiator between now and then has been the rise of paperless, or digital, mortgages. The technology emerged after the crisis, and tech-savvy home buyers are using websites such as Rocket Mortgage to at least get a rough estimate for how large of a mortgage they are eligible for.

While the general public remains hesitant to fully adopt the technology (bankers compare it to the early days of shopping on Amazon) the consensus is digital mortgages are here to stay.

Joel Kan

“I think what we’ve been hearing is that the industry or at least homebuyers or prospective borrowers are growing more comfortable with electronic transactions from a purchase standpoint,” Kan said.

As recently as three years ago, Kan was hearing feedback from lenders that a lot of people, including first-time homebuyers, weren’t entirely comfortable with doing everything over the phone or online, comparing it with “a black box.”

“You aren’t really seeing what’s happening,” he said. “You wanted to go into a branch or talk to someone on the phone or meet with someone to go through things, but it seems we are moving away from that.”

A drive to lower costs and trim the required time to close loans is also driving the push toward a digital model. As rates increase, Vessely believes the desire to move toward paperless mortgages will increase, too. “I will clearly state that is the path we need to be on,” he said.

The Iowa Bankers Mortgage Corporation has been looking at vendors to provide the technology to its member banks. The endgame is to make home buyers feel comfortable enough to complete the entire process entirely on their phone.

“You can do all you want to collect information, but you’ve got to be able to use it to get into the document phase where you close the loan,” Vessely said. “That’s where the rubber meets the road.”

Kirk Leverington is firmly of the opinion that the industry is heading toward paperless mortgages. He’s vice president of corporate strategy at San Francisco-based ONYXDirect.com. Launched in 2014, ONYXDirect says it allows home buyers to apply for a loan and get approved within 24 hours, and get to closing in half the time of the industry average.

“What we’re driving toward is not cutting closing from three weeks to two weeks to one week,” said ONYXDirect President Lucas Filinski. “Our ultimate goal is instantaneous gratification for a mortgage. And we do believe we can get there.”

Leverington said as digital-savvy millennials mature, they will drive the shift away from the traditional ways of getting a mortgage.

“The same way that consumer expectations are changing around other industries like retail, we think the same thing is going to happen to banking,” Leverington said.

He expects the trend of financial institutions partnering with fintech companies to rise, which will allow banks to leverage fintech industry expertise to speed implementation of the technology.

Gaytko has had an inside view of millennials’ comfort with technology as he’s watched his 25-year-old son toy around with the idea of buying a home. Despite his son’s and other millennials’ familiarity with doing everything online, Gaytko thinks it will take time for digital mortgages to make major inroads.

“When you go to make a decision on a home, I still see that the young consumer and young families want their hand held through that process to understand what’s involved,” Gaytko said. “And I still see a strong role that community banks can play in that arena, because it is a big decision for them.”

While paperless mortgages, housing supply and millennials are among the factors that set this strong housing market apart from the previous one, there is one certain and inevitable commonality: It will eventually have to end.

Battle-hardened bankers who survived the last crash will pore over data, lean on their experience and weigh elements of the market that weren’t in place a decade ago as they plot their next moves. They can also lean on the knowledge that as dark as those darkest days were during the crisis, eventually the market will turn the other direction.

“The country is going to go through the normal economic cycle, just like we’re probably close to a downturn in the coming years if we’re not getting there already,” Means said. “A lot of times it’s just a healthy downturn. Sometimes you just have to take a step back and regroup, then go onto the growth stage again.”


Editor’s note: This article originally appeared in January 2019.