On loan

A look at mortgage activity, products, and consumer preferences.

Moving in the opposite direction from the general economy, the housing and mortgage industries recorded a spectacular year in 2001.

This year promises to be yet another good one, but the mortgage refinancings that fueled the 2001 explosion may be drying up.

by James T. Berger   In a year where manufacturing was deep in recession with more than 1 million jobs lost and an anemic stock market, it was the housing sector that stepped up to fill the void. According to Mortgage Banking magazine, "Fearless consumer spending, construction, and mortgage financing literally have kept the U.S. economy afloat."

Tom LaMalfa, managing director of Wholesale Access, a Columbia, Maryland, research and consulting firm specializing in the mortgage market, attributes the booms in mortgages and housing to a fundamental change in the way Americans view their homes as an asset.

"Housing as an investment has come to the forefront," said LaMalfa, "especially with the bubble popping in the equity markets. A lot of money has been funneled in the last couple of years from equity markets into the housing market. People have cashed in their chips and bought larger homes."

He also sees debt consolidation as a boon to the mortgage market. Consumers are trading their high credit-card debt for home equity loans, which promise both lower interest rates and the benefit of a tax deduction.

In addition to a boom in the mortgage originator’s volume (top line), the profitability (bottom line) has kept pace. Atlanta-based STRATMOR Group, a mortgage banking and consulting firm, reports the industry’s profitability, measured by the weighted average return on equity, increased to 19.6% in the first six months of 2001 compared with 15.8% in 2000 and 19.1% in 1999.

However, the segment of the industry that services mortgages didn’t fare too well. They saw their profits decline with the rise of refinancing. Servicing income includes amortization of servicing rights, impairment, hedging, and sale of servicing rights. The Mortgage Bankers Association of America (MBA) reports that servicing income fell to a loss of $42 per loan compared with a profit of $106 in 2000.

Another factor positively impacting the mortgage market is the decision by Fannie Mae and Freddie Mac to raise the single-family conforming-loan ceiling from $275,000 to $300,700, a 9.2% increase. This increase makes it possible for a larger number of homeowners to secure lower-cost financing. Many homeowners who had to pay the premium rates for jumbo mortgages are now able to refinance into lower conforming-mortgage rates.

Which loans are buyers choosing?

With interest rates so low, the product of choice in 2001 was the 30-year fixed-rate loan. ARMs had only 12% market share in the $1.8 trillion 2001 mortgage market. This was down from 23% in 2000 and marked the lowest share since 1998, when the adjustable-rate product had 11% market share.

During the year, the spread between the one-year ARM and the 30-year fixed varied from as low as 0.21% at the beginning of the year to 1.91% at year-end, according to Freddie Mac.

A Freddie Mac survey showed that as lenders were deluged by requests for 30-year fixed mortgages, some even stopped offering ARMs. In fact, only 16% of lenders in the Freddie Mac survey offered three-year ARMs, compared with 50% in 2000.

One product that maintained its attractiveness is the so-called hybrid ARM. These loans represent a cross between the fixed-rate and ARM products. They resemble fixed-rate mortgages in the early years and at some future point convert to adjustable rates. For example, the "five-one" hybrid offers a fixed rate for the first five years and then adjusts every year for the next 25 years.

With the FHA now able to insure hybrid ARMS, thanks to language included in the 2002 VA/HUD Appropriations bill, 40,000 more people will be able to purchase homes, according to a statement by the MBA.

In early January 2002, the 30-year fixed-rate mortgage had a rate of 7.33%, and the one-year ARM was in the 5.5% range. However, the five-one hybrid carried a 6.46% rate. That five-one hybrid would result in a monthly mortgage payment of $1,259 for a $200,000 mortgage compared with $1,375 for the 30-year fixed loan at 7.33%. Over five years, the hybrid would save the homeowner $9,000. Of course, a homeowner who stays in the home and does not refinance runs the risk of uncertain rates at the end of the five-year period.

Another category of products that seems to be gaining favor is loans requiring little or no down payment. Coming up with the down payment has traditionally been one of biggest obstacles to homeownership. Today, an owner with a substantial income who is willing to incur slightly higher interest rates can buy a home for as little as 3% down or, in some instances, nothing down.

Minority homeownership hit a record level of 48.8% in second quarter of 2001, and the Bush administration is proposing initiatives to increase housing opportunities for minorities and low-income families. President Bush is proposing a $200 million American Dream Down Payment Fund and expanding the Section 8 Homeowner Program to help low-income families overcome the initial cost of owning a home.

Technology savings (and costs)

Increased productivity through technological advancements has contributed to increased originator profitability. In retail production channels, the "fully loaded cost to originate a loan in the first half of 2001 was driven down 34% from $3,500 to $2,300 since last year," said STRATMOR Group partner James M. Cameron.

Automated underwriting has reduced lenders’ fixed costs. However, gains from automated underwriting may be offset by increased investment in even more technology, said Cameron. Lenders continually strive to integrate various platforms, improve connectivity to the consumer, upgrade point-of-sale origination systems, and process loans out to the secondary markets.

Buyers still "window shop" online

The online mortgage lending industry continues to struggle. While increasing numbers of consumers are going to the Internet to shop rates, most prefer working with lenders in person and over the phone when consummating the deal.

The MBA reports that 86% of online customers used the Internet to obtain information, yet only 12% applied for a mortgage online. Of that percentage, a mere 3% followed the transaction through to closing.

"I don’t believe there will be pure Internet lending where there is no human contact," said Daniel Harris, chief executive of LowestLoan.com, a mortgage broker licensed in 29 states.

Meyers Internet, Inc., a provider of infrastructure for online lenders, announced last fall that online mortgage traffic hit an all-time peak. They announced that they processed 45,000 mortgage applications in October representing more than $7.2 billion in online loans. However, CEO Warren H. Myer admits, "Most consumers shop rates and programs on a Web site but then apply over the phone, in person, or by mail."

The combined online/in-person model seems to be working well for many well-established lenders. A recent American Banker article reported that only two of the top 10 online lenders were Internet-only operations. E-Loan and Quicken Loans ranked third and fourth on that list, with Countrywide Credit Industries and Washington Mutual at the top.

Aiding the cause of online mortgages is a framework for the development and deployment of online standards by the MBA and Fannie Mae.

"Transparent standards developed by an independent industry body are key to ensuring a level playing field in the deployment of new technologies," said Andrew Woodward, 2001 MBA president. "This agreement will speed the process of bringing innovative technologies to the nation’s mortgage lending system while ensuring industry-wide participation in designing and maintaining the standards for electronic transactions."

James T. Berger is freelance writer and marketing consultant in the banking and mortgage field. He is based in Northbrook, Illinois.

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Learn why mortgages rates don’t fall when the Fed cuts rates.

View the 2002 mortgage finance forecast.

"A lot of money has been funneled in the last couple of years from equity markets into the housing market. People have cashed in their chips and bought larger homes."