House Riches

Jerry Schiano, a former New Penn Financial executive and founder of home equity lender Spring EQ, doesn't mince words, "First mortgage business is dead."

The reasons are obvious.

“One, we’ve seen a run-up in home price appreciation. Two, recently, until the last year or so, consumers would tap home equity through cash-out refinances. Because of where the rates are, refinancing your first mortgage just doesn’t make sense right now because nobody wants to go from a 2.5% to a 6.5% [mortgage rate] to get $50,000 or $100,000,” Schiano says.”I think there is some consumer education needed to get consumers to understand that home equity is a viable option through either a HELOC or home equity loan.”

One thing's for sure - with non-mortgage consumer debt on the rise due to inflation and dwindling pandemic-era stimulus funds, industry experts say HELOCs and home equity loans represent a win-win for financially-stretched consumers and lenders hungry for new loan portfolios.

“It’s not for the faint of heart and that’s really the challenge of this business, why more people haven’t gotten into it,” Schiano says.

HELOCs and home equity loans are typically more affordable for borrowers than other options like credit cards or personal loans. For the most part, HELOC rates have remained between 6.8% - 8.4% this year. As of mid-May, the average APR offered on new credit cards was 23.98%, according to LendingTree.

Watch it on The Interest: Rocket Buyouts, Sellers Still Winning

Tappable home equity has increased by $3.4 trillion in just the last three years, according to Black Knight, a data analytics provider for clients in the housing industry.

Meanwhile, home equity line of credit (HELOC) originations rose 7% year-over-year in the fourth quarter of 2022 and home equity loan originations jumped 31%, according to TransUnion’s Q1 2023 Credit Industry Insights Report. HELOC originations totalled 299,000 units in the fourth quarter of 2022, while home equity loan originations reached 264,000 units.

TJ Milani, chief operating officer of Figure Technologies and chief financial officer of Figure Lending, says the bad economics of cash-out refinances in a higher interest rate environment have driven the recent surge in home equity loan originations. At the same time, the last decade has seen more transformation in the home equity marketplace.

“There’s been a lot of innovation historically, or trying to do innovation, on the first mortgage product with other different fintechs. On the equity release and second lien products, there really hasn’t been,” Milani says.

It created opportunity for nonbank lenders to get into the space dominated by retail banks and credit unions.

“As interest rates rose for this specific product, it made it much, much more attractive for consumers. A lot of the folks that actually do these products aren’t the big banks really. It's a lot of the community banks that serve their consumers in specific markets,” he says.

Milani predicts tighter credit conditions for smaller, regional banks due to recent turmoil in the banking industry, in addition to higher interest rates, will continue to work in the favor of nonbanks stepping into the home equity lending space.

“I think there really is a macro trend given what happened with SVB and First Republic and Signature and all these guys. I think there's going to be a significant pullback in access to credit across some of these smaller and regional banks. That's ultimately, and unfortunately, going to hit products like this. So, I think the time is ripe, given where interest rates are making cash-out refis less attractive, given the secular change that's going on with banks and their liquidity positions, given the rise in technology within these products. I think, in general, the next 3, 4, 5 years are going to be super, super valuable for this market.”

The Rationale For Borrowers

Consumer surveys that TransUnion conducted show the primary reason homeowners tap into home equity is for home improvements. The second is to pay off higher-interest-rate, non-mortgage debt – such as credit cards, personal loans, and even auto loans – with APRs “quite high” compared to a couple of years ago, Mellman says.

But, as Schiano sees it, the borrowers who would or could tap equity aren’t the size of the entire tappable-equity market. Some people own their house free-and-clear and have a lot of savings, but much of society does not.

“If you look at the home equity marketplace,” he says, “a number of people take out home equity lines just in case, in case something happens. And then there’s a number of people who take out debt consolidations. They’re two different aspects of that tappable equity marketplace, with two different reasons for borrowing. If we do a debt consolidation loan, which is a good percentage of our loans, we make sure we pay off the debts we’re consolidating because if you’re a personal loan company, they’ll do a debt consolidation loan, and then they give somebody $15,000 because the person says they want to consolidate their debt. But they’re not really paying off those debts, they’re counting on the customer to do that. What we do, as a part of our process, is pay off those debts.”

Tom Finnegan, a principal at Stratmor Group, a mortgage advisory firm, makes the case that home equity lending provides an opportunity for lenders to reach potential borrowers whose properties have appreciated, but are reluctant to sell and give up their lower rate. When mortgage rates are up, a home equity loan or line of credit offers borrowers with rates less than 3% the chance to access cash.

Banks and credit unions have always been in the equity business, but independent mortgage banks (IMBs) have not traditionally offered home equity products due to the minimal commissions for originators and irregular investor interest, Finnegan says.

However, Finnegan believes IMBs now have an opportunity to get creative and bill themselves as organizations that want to work with their customer base through all interest rate cycles.

“Today they might be just needing some equity and some cash to send the kids to school or something, but later on they may be trading homes, downsizing … there may be a full, rate-reduction refi if rates ever go down again, and you could consolidate that debt in. There may be opportunities down the road if you believe in a customer-for-life or client-for-life strategy. Making sure that you can serve their needs with this particular touch point, today, certainly would accrue to your long-term, customer-for-life strategy.”

One option Finnegan sees is for IMBs to partner with local or regional banks as investors who would be able to hold the loans on their balance sheets. Some loan officers may view home equity lending as a distraction from the goal of a first mortgage loan plus a full commission, but training LOs on home equity products can help institutions improve their client-for-life strategies and increase revenue at a time when many lenders – and originators – are hurting.

Equity Motivators

Or, look to the near term.

“If a first-mortgage company is trying to sell cash-out refinancing, it’s not a slow market, it’s a dead market,” Schiano says. “We tell our mortgage banking customers, mortgage brokers, just because mortgage rates have changed, it doesn’t mean that people don’t have a need to consolidate their debt. So, the mortgage originators can decide to not participate in that market, and they can focus on purchase-money loans, but the competition there is fierce, and the margins are tight, and there’s still more originators than there are loans.”

In a down market, or even a vibrant market, originators should be in the business of adding value to their customer base, Schiano believes, echoing Finnegan’s emphasis on customer-for-life strategies. “If it’s the right thing to do to give somebody a home equity loan, rather than a cash-out mortgage, they should do the right thing. And then, if they do the right thing – and maybe I’m old-school – I believe if you treat people right, they come back to you time and time again.”

In Spring EQ’s third business channel they partner with large first-mortgage companies who don’t want to fully get into the home equity business. Schiano tells these partners that carrying home equity products keeps customers – and business – in-house.

“Sometimes, offering the home equity line helps solidify the sale for cash-out refinancing because, basically, you’re giving people alternatives. The companies that don’t do that are basically telling the customer, ‘Boy, why don’t you go get a home equity quote outside of us, and then if you don’t like that, come back to us.’ I think it’s a consultative selling approach that even in good times people should use it. Now, they should do it completely, in this time, because this is the product – they’re not going to sell the other product, not enough.”

A HELOC study which Stratmor conducted showed that the top-three motivations for lenders to offer home equity products were: meeting borrower needs; supporting customer relationships; and, providing LOs with all products available.

These responses imply that lenders offer home equity products primarily in support of their customer-first orientation. Unsurprisingly, many borrowers aren’t aware of equity as an option.

TransUnion’s Mellman identifies a dearth of knowledge among consumers about what home equity products are available and who qualifies as a primary obstacle for lenders.

“There’s not big awareness on home equity as a lending class on the whole. Older people like me can remember when home equity was a standard product that was often thought of in the same vein as a mortgage or a credit card. The industry has to remember that there’s a whole generation – basically since the great financial crisis to now – where home equity has not been a common product.”

The volume of home equity originations rose 53% year over year in 2022, but, curiously, the trend has not continued through the first few months of 2023. Meanwhile, consumers’ non-mortgage debt has been increasing with inflation, added costs, and the spending down of pandemic-era stimulus money.

Milani acknowledges that there’s been a drop so far in 2023, but with a market this massive, doesn’t see the cooling off as cause to worry. Rather, he sees a market that’s sensitive to interest rates and fears of a possible impending recession.

“It's such a big market and we've barely cracked the surface of what we're doing. I think there's just a ton of room to grow. If this was a $12 trillion market and there were $3 trillion of originations already, I'd tell you differently, maybe. But, a lot of folks are sitting on equity in their homes. A lot of folks still have various needs. And with credit card rates at 27% and personal loan rates at 18, 19%, and even first mortgage rates at 6%, this is a very good alternative product.”

Crisis Flashback

In addition to affordability, an attractive feature of HELOCs is flexibility, Schiano says.

“It depends on what the customer wants. HELOCs are IO (interest-only) payments, so they have lower monthly payments and conceptually, they could draw more. But, HELOCs have seen a run up in interest rates because prime keeps going up and up and up and up. Maybe it's stopped now, whereas the closed-end loans, whatever you lend to somebody is the rate throughout the loan.”

Open-end lines of credit can be drawn against for multiple purposes over a period of time, as well as acting as a liquidity safety valve for borrowers worried about month-to-month cash flow. Because closed-end home equity loans are typically fixed-rate products, the flexibility and variable interest rates of HELOCs may be more attractive to borrowers if and when rates go back down.

As to why some consumers might be less eager to tap equity, Stratmor’s Finnegan thinks there may be a reticence among borrowers who remember the housing crisis of 15 years ago and are wont to put their house on the line. This makes consumer education of paramount importance, “depending on how the customer enters the bank, whether it’s through the web or contact with their previous mortgage loan officer, that the right discussion points – not scripting but the right counseling occurs with the potential customer, no matter what touch point they enter.”

Mellman, for his part, sees a huge opportunity for lenders to use data like TransUnion offers to identify individual borrowers who might benefit from home equity products.

Doing so would allow lenders to adopt a tailored approach for educating consumers about their options.

“Educate consumers on how much home equity they have, and when you combine that with other data assets like how much debt they’re sitting on, what interest rate that debt is, then you can do the simple math and do a value proposition for each consumer. Ryan, you can save $300 a month; Joe, you can save $250 a month.”

Though down from $210,000 early last year, Black Knight analyses from April show the average mortgage holder still has $178,000 in tappable equity to borrow against while retaining a 20% equity stake in the home. Yet, as interest in home-equity products increases, Mellman believes lenders should know that it’s not just mortgage holders who are tapping home equity, but also consumers who own their properties free and clear.

“That is a group of consumers that oftentimes are not in the conversation," he says. "While they don’t quite do the volume that mortgage holders do, they still do significant volume on starting to tap their home equity. It’s an important consideration to have for the lending community.”

At Spring EQ, the priority for originators is always affordability and debt ratios for consumers. Prioritizing borrowers’ best interests in origination is part-and-parcel of being a good credit brand, Schiano says. The key to any borrowing – be that a credit card, auto loan, first mortgage, or home equity – is to make sure people can afford the product and understand the ramifications of their borrowing decisions.