Are you prepared for the end of the refinance era? If not, then I suggest you get your business ready, because a change in the fundamental make-up of our industry is not far away. Recent reports and comments from the Federal Reserve and economists with major U.S. banks describe a housing sector that has fundamentally changed from historical norms, and one that will not return to those norms during our lifetimes. However, we will almost certainly see mortgage rates rise to their historical norms.
The recent period following the housing bubble has seen mortgage rates significantly below historical levels. Once rates rise, they are not likely to revisit these levels—short of another monumental crisis. We need to let consumers know that now may be the last chance many in the U.S. will have to refinance for cash-flow improvement or to move to less risky mortgage products.
During the aftermath of the housing bubble, the Federal Reserve has provided substantial liquidity to the U.S. economy that has helped to artificially drive and keep mortgage interest rates low. In so doing, the Federal Reserve has “lubricated” the troubled housing sector. The Fed’s “Zero Interest Rate Policy” has helped keep the mortgage industry afloat over the past few years. What will the mortgage industry look like when the liquidity ends and rates rise beyond the level of most current in-force mortgages? Simply put, it will be a much smaller industry that is overwhelmingly focused on purchase financing.
What evidence supports this conclusion?
First, in early February, Federal Reserve Chairman Ben Bernanke submitted a Fed study on the state of the housing sector to Congress. In it he stated, “… restoring the health of the housing market is a necessary part of a broader strategy for economic recovery.” But he added that there were many “frictions” in the market that were preventing that recovery, including ongoing foreclosures and the resulting overhang of housing supply.
Moreover, a paper by economists at JP Morgan Chase, Bank of America, and the Universities of Chicago and Wisconsin released in late February argues that the Fed should be very cautious about policy responses to those frictions. They write, “A mistake would be to adopt policies that seek to artificially boost house prices and residential investment going forward.” The authors believe that the housing bubble represented a “dramatic overinvestment” (based on historical norms) in housing and that it will take decades for the market to return to normal. Their proposed prescription—as painful as it might be—is to allow for the housing sector to revert to historical norms. This would include higher loan-to-value (LTV) ratios and higher average interest rates. Clearly, they would argue against any further quantitative easing from the Fed.
This same paper makes another point that is the focus of this article, namely that the current low interest rate environment, brought about through a zero percent Fed Funds rate for the past three years and $2.3 trillion in asset purchases, have enabled almost everyone capable of benefitting to benefit. Commenting on this aspect of the paper, president of the St. Louis Federal Reserve Bank, James Bullard, said, “Those that can respond to the lower yields have done so already and those that cannot will not be influenced by further policy actions because they are backed up against sharply binding collateral constraints.”
The implication for the mortgage industry is quite simple … even further quantitative easing including the purchase by the Fed of additional mortgage-backed securities (MBS) is not likely to significantly increase refinancing activity.
So … where does that leave us as an industry?
The fact is that we could be one news story away from significantly higher interest rates. Rates have been held low by Fed action for sure, but also by a year’s worth of bad news that may be quickly improving. The ongoing weakness of the U.S. economy and job market is reversing course, the negative after-effects of the Japanese Tsunami (at least on the global economy) is waning and the impending default of Greece and the collapse of the European banking sector are delayed at worst, avoided at best.
Currently, concerns over the price of gas on the U.S. economy due to tensions in the Middle East, along with the Federal Reserve’s purchase program for mortgage-backed securities, known as “Operation Twist,” are helping to keep mortgage rates near all-time lows. But these beneficial governors on mortgage rates could decline in significance, or be eliminated altogether, very soon. Operation Twist, for example, is scheduled to end by the middle of 2012. The fact is that the era of refinancing is coming to an end sooner rather than later.
What should mortgage professionals do?
I have three suggestions:
►Be a Town Crier: If it’s truly last call for refinances, then we owe it to our former customers and communities to let them know this fact. In particular, those who have adjustable-rate mortgages (ARMs) should consider a refinance into a fixed loan to avoid interest rate risk in the future. Moreover, those with 30-year loans should consider refinances, at these lower rates, into shorter duration loans. The depressed forecast for housing values for years to come increases the financial advantages of paying off a mortgage more quickly.
►Re-engineer your sales process: We cannot expect that the same way we have done business in the past is going to work in the future. Marketing for purchase business is distinctively different from marketing for refinance business. The sales cycle is going to be longer and more is going to be expected of the mortgage professional in the future. We have to be prepared to help our customers analyze the pros and cons of homeownership—which are no longer the same as they have been.
►Listen to and engage with your customers: As every service professional knows, the ability to listen to and respond appropriately to your customers is what separates the great from the “not so great.” In the future of the smaller mortgage industry, the “not so great” will quickly be out of the business. Mortgage professionals are problem solvers and dream facilitators. That can only happen when we listen carefully to the folks with which we are privileged to have a chance to work.
The end of the refinance era is upon us. Are you prepared?
John Walsh is president of Milford, Conn.-based Total Mortgage Services. John founded Total Mortgage Services in 1997 with a customer-centric approach and a mission of responsible lending. He may be reached by e-mail at [email protected]