What factors regulate mortgage product innovation and how do we encourage this innovation over the long-term?
DENVER; Dec. 15, 2020 – Innovation is a topic of conversation in our shop on a daily basis. Not only is it central to the value we bring to the industry, but it’s also what we work to help our customers deliver for the home loan borrowers they serve. Often, when we speak of innovation, we’re talking about technology, but that’s not always the case.
Technological innovation continues to be an important goal for the institutions we serve, many of which have been leaders in this area for decades. However, increasingly, I find myself considering the state of product innovation in the mortgage industry.
Prior to the financial crash of 2008, as the industry was breaking volume records every quarter, our industry had hundreds of different mortgage loan products. The industry could meet any imaginable borrower need and home values were rising in the face of increased demand.
After the financial crash, all of these products went away and borrowers were left with basically three choices: a Fannie Mae or Freddie Mac 30-year-fixed-rate mortgage or an FHA loan product.
A few years ago, we saw product innovation returning, with a healthy mix of Non-QM and JUMBO loan products to meet the needs of consumers in a growing economy. Then, the pandemic struck earlier this year.
The factors that regulate mortgage product innovation
Watching our product menus grow and shrink over time left me thinking about the factors that regulate this important function in our industry. What is required to see product innovation take hold? What shuts it down?
Product innovation has everything to do with investor appetite. But in our business, investor appetite has everything to do with managing risk and their assessment of the country’s economic situation. If investors perceive high risks, they will shut off liquidity to certain loan products and mortgage bankers will pivot to the remaining products to meet borrower demand.
This makes perfect sense when you realize that mortgage bankers are bankers first and that no other group of professionals is more adept at risk management. In the housing market, these risks come in the form of changing borrower circumstances, credit market conditions, real-time interest rate, inflation and home prices.
As pointed out by Harvard’s John Y. Campbell in his 2012 paper on Mortgage Market Design, “the initial mortgage rate compensates lenders for the balance of risks that they bear.” However, as we learned in the subprime lending crisis that led to the great recession, rates cannot completely protect lenders even when the Fed reduces the prime rate to zero.
When the pandemic struck the US in March, many states issued shelter in place orders that effectively took workers off the job and sent them home. This increased the risk that borrower circumstances would deteriorate rapidly and led many warehouse lenders to pull liquidity from the Non-QM sector, which dried up overnight. Many non-QM lenders shut their doors.
As Federal state government programs began providing assistance, grants and other incentives to employers and additional unemployment benefits to workers limited the long term impact and by May the non-QM market was already returning.
Encouraging mortgage product innovation
So, what does it take to create an environment that will foster mortgage product innovation over the long term? It’s really about whether Wall Street has access to mortgage-backed assets that can be both effectively securitized and managed from a risk perspective.
Of course, that means that everyone else in the value chain has to have access to transactions that are both profitable and safe over the short, medium, and long terms. In our world, that comes down to more accurate, robust information sooner in the process, which is what our lender customers have always required and what we here at Mortgage Cadence specialize in delivering.
To learn how, contact us today to schedule a live, tailored demo of the new Mortgage Cadence Platform (MCP).
By Joe Camerieri, EVP, Client Account Management at Mortgage Cadence
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