Mortgage Risk Will Increase As The Market Tightens This Year
As kids, we all played musical chairs. It was an exciting, frantic game full of fun and laughter. That is until you were the one left without a chair.
The longer the game goes on, the fewer seats exist and with each passing round and the pressure intensifies. Toward the end of the game, those final, frenzied lunges leave someone falling flat on the floor.
The musical chairs equivalent in financial services might have last occurred during the financial crisis of 2007 to 2009, particularly for mortgage lenders. When the financial crisis hit, mortgage lenders were left scrambling. Those that had more effective risk controls could continue to play. Those that didn’t, well, they were left without a chair and went out of business.
This Year Rising Interest Rates and Property Values Can Drive More Growth Or Take It Away
For the last several years, the mortgage lending business has enjoyed strong volume and revenue. But, with interest rates beginning to creep up, loan application volume decreases are inevitable. We are already seeing the market tighten.
When the lending environment changes from one of falling interest rates combined with rocketing home values to that of rising rates and slower appreciation, pressure on mortgage lenders intensifies.
The lenders that are very good at managing risk will likely always find a seat in the game, but those that struggle may be out when the music stops.
Small Changes In Interest Rates Will Create More Risky Loans
As recent data indicates, even small increases in interest rates have a material impact on mortgage loan application volume. This is true both for refinances as well as purchase loans. Refinances, which currently account for 40-60% or more of total volume, sharply decline when the interest rate jumps. A decrease in refinance volume is felt immediately given its share of overall volume. Interest rate increases mean that purchase volume drops, too. Borrowers who were just on the cusp of qualifying may no longer meet lending standards.
As the market shrinks in many geographical markets, buyers and brokers will have incentives to push the boundaries of their truthful financial outlook to get deals closed. Sometimes that will involve falsifying employment or income data or material misrepresentations of other sorts.
Property Appreciation Will Play A Role Too In Increasing Risk
Another factor that will certainly affect loan application volume is the appreciation of home values. As values have soared, many have enjoyed the privilege of tapping into their new-found equity via cash-out refinances. As value appreciation slows with higher interest rates, the next round of equity is not there to cash out and that will also have an impact on mortgage application volume.
As a result of these likely trends, lenders may be required to consider one of the following options:
- Allow their loan origination volume to shrink based on their current (or similar) credit quality standards. This might involve cutting costs, including staff and reduced revenue and profit.
- Expand (i.e., loosen) their credit quality standards to create more volume. This could unintentionally create an environment where some borrower misrepresentations occur to get deals through.
Lenders with robust controls best positioned for success
For those lenders that choose to maintain revenue targets in a contracting market, relaxing underwriting standards or expanding the pool of potential applicants can be effective but comes with challenges. Taking on a bit more risk by targeting borrowers with even slightly worse credit quality can seem fairly benign but can in fact lead to downstream delinquency or fraud losses if not managed properly.
For lenders that have solid risk evaluation and fraud detection procedures, downstream delinquency issues can perhaps be mitigated to within expectations. However, lenders with less sophisticated risk management tools and processes, less visibility to intermediary (broker) risk, and non-data-driven fraud review processes may enjoy the upfront volume but may feel the sting of delinquencies later. And the search for volume will only get more intense as loan application volume continues to decrease.
Point Predictive Helps Mitigate Risk and Reduce Cost of Underwriting
Point Predictive can help lenders streamline underwriting processes and mitigate risk Point Predictive has solutions to help lenders add automation and mitigate risk. The time is perfect to ensure controls are robust as the market contracts. Find out more about how we can help you find and keep your seat in the next game of mortgage lender musical chairs.