Fellow NPR nerds likely spent this past week eagerly awaiting excerpts from an interview with Messrs. Bernanke, Paulson and Geithner (the “Committee of Three”) marking the 10th anniversary of the financial crisis that precipitated the Great Recession. As if to underscore its proximate cause, Paulson remarked that “mortgages are ground zero of, you know, the crisis…”
A decade on, US housing seems to be in decent shape. The ratio of housing debt-to-equity is well within secular bounds, and the total value of the market has finally surpassed the 2006 pre-crisis peak. But things are not quite as peachy with the mortgage market, a $15-trillion business that accounts for over three-quarters of home purchases.
Fannie and Freddie
Dominating the mortgage market with half of new mortgages originated under their auspices are Fannie Mae and Freddie Mac (Note: this pair was mentioned 36 times in the aforementioned NPR interview). Along with Ginnie Mae and together known as the “Agencies,” the troika have an 80% share of new mortgages. Fannie and Freddie have lately been on a winning streak, driven by the housing recovery of the past few years. Yet, both are still effectively nationalized under conservatorship and required to deliver nearly all earnings to the Department of the Treasury and, hence, are structurally impeded from assuming the risks attendant with innovation.
Richly ironic is how the new lowered corporate tax rate has forced the duo to write-down a combined $15 billion in deferred tax assets, which, in Fannie’s case, has compelled another multi-billion-dollar federal bailout. The infusion, while temporary, only serves to highlight how this unhealthy situation must be remedied for the industry to move on. Treasury Secretary Mnuchin has stated, repeatedly, that housing finance reform is a “top priority.” He has also reaffirmed support for traditional mortgages, saying, “I think the 30-year mortgage has been a fundamental part of our mortgage finance for as long as people can remember.” Assuming this administration can execute on this priority, another issue rises to the fore.
Dominance of the 30-Year
Does the primacy of the 30-year mortgage, mainly of the fixed-rate variety, make sense anymore? The product that arose from the Great Depression solved the need for stability, defined as staying put for decades. This solution, however, gave rise to a host of complications around the mismatch between the long-lived mortgage loan asset and shorter-term liabilities needed for funding that has resulted in the occasional catastrophe.
The mismatch that must also be considered these days is the one between the product and the needs of the Millennials, the largest single cohort of recent home buyers and now just entering their prime nesting phase. Despite the buzz about co-living and the sharing economy, 85% of Millennials still expect to own a home.
At a time when Millennials are looking for affordability, engagement and flexibility, this mismatch is increasing. This generation is entering a robust housing market later than previous ones and burdened financially by the detritus of the Great Recession: weak wage growth, tougher mortgage standards, and soaring student loan debt. Is it any wonder, then, that despite their substantial presence in the home purchase market, Millennials’ home ownership rates are still lower than those of prior generations?
This cohort, which came of age prioritizing experiences over possessions and quality of life over pay, will continue to demand flexibility even as they gain career momentum and move into their nesting/home ownership stage. Other generations are twice to three times more likely to define homeownership as permanent. These are not ones to settle for 30-year commitments.
Millennials seeking delight invariably suffer disappointment from the mortgage loan, a product that emphasizes “widget-making” over experience. As I discovered from a group of MBA’s while lecturing at a business school last month, not even market-leading Quicken Loans escaped criticism for its “old-school,” phone-heavy contact model. Worse yet, the prime directive during the repayment phase, to drive down costs, generally through minimizing customer contact, also alleviates opportunities that may arise from continued engagement. A 2017 Accenture study showed that “mortgage costs are a fraction of the money in play during the first three years of home ownership.”
Solving for Affordability
There are plenty of efforts to make the mortgage more affordable. Among established lenders, we have seen increased appetite for sub-20% down payments. Bank of America’s CEO Brian Moynihan stated last year that lowering the down payment requirement to 10% from 20% “wouldn’t introduce that much risk but would help a lot of mortgages get done.”
Meanwhile, fintechs have sought to reduce mortgage production costs, currently averaging $8,000 per loan, by both innovating the tech to streamline the fulfillment process and reducing loan officer compensation, which makes a major impact since commissions are typically at 1% of total loan amount.
What About Engagement and Flexibility?
The drive to innovate on engagement and flexibility highlights not only the limits to what can be done within current product boundaries, but also the poverty of imagination afflicting the space.
What can be done during the repayment phase to increase engagement? Loan Depot, for one, has aggressively pursued cross-sell opportunities into personal loans and home improvement financing. It’s a start, but the customer needs more than an occasional sales pitch to value the attempt at engagement.
As for flexibility, we need to think beyond the 30-year standard. But so far, creative financing-based solutions, including equity-sharing arrangements (e.g., Unison and Point ) or lease-to-ownership programs (e.g., HALO), represent a tiny drop in the bucket.
Where’s the Fire?
The blunt truth is that, over the past decade, the mortgage business has been defined by increasing scale, low rates, and an aversion to product innovation. Consumers with the requisite credit quality have become acclimated to nearly free money, inured to constraints of the standard product. So, why change now?
Looking toward the horizon, there is increasing likelihood that the need for innovation outlined above will match with catalysts of actual market change, in the form of housing finance reform and a more normal rate environment that will spur greater mortgage product differentiation.
Change will come. But, until then, the 30-year mortgage remains the standard.
Marvin Chang leads new product commercialization efforts at Caliber Home Loans, a major non-bank mortgage company. He is on a mission to demonstrate that the incumbents in the space can out-dance the insurgents. All views in this article are his own.