Lenders Need Alternative Products To Attract Additional Customers
Adjustable-rate mortgages, hybrids and pledged asset loans can help increase volume.
By LARRY A. GOLDSTONE
While the mortgage industry is moving toward more automation and a simplification of processes, the demographics and financing needs of a growing customer base continue to become more complex.
The number of unique customer segments increases as American families and workers become more and more diverse. No longer is there an attitude among lenders and investors of a "one-size-must-fit-all" product strategy. As customers' needs change, the need for new and different mortgage programs and options must change, too.
Lenders who want to attract more customers and gain market share need to stay focused on enhancing their customer's experience by offering mortgage financing options to meet a wide variety of individual borrower needs and scenarios.
For example, there was a time when offering an adjustable-rate mortgage (ARM) with a low initial "teaser" interest rate and a one-year repricing frequency was considered to be an "alternative mortgage product line."
This is no longer true. "Hybrid," or intermediate fixed-term ARM loans - loans that have an initial fixed-rate period of three to ten years before adjusting either annually or semi-annually - are reshaping the market by offering borrowers alternatives to a fixed-rate loan that will save them money on their monthly mortgage payment.
Intermediate fixed-term ARMs give customers the best of both worlds: the stability and peace of mind associated with fixed payments for an extended period of time, a 30-year term with no troublesome balloon payment, and the flexibility and affordability of an ARM with lower monthly payments and more favorable underwriting requirements.
It's also formerly true that ARMs were only marketable to a customer in a rising interest rate environment. In that environment, ARMs were an easy sell, compared to the higher interest costs of a standard 30-year, fixed-rate loan.
With the advent of "hybrid" ARM loans, ARM products are no longer only attractive in a rising rate environment. They are now standard fare among most lenders and a highly attractive option for many borrowers, whether they are buying a new home or refinancing their existing loan.
Important features
Important features of a hybrid ARM are the margin and interest rate change characteristics once the fixed-rate period has passed.
Many borrowers are likely to ignore these features, thinking they will just refinance the mortgage prior to the end of the fixed-rate period. Because of this, many lenders are able to set the margin at whatever rate they like.
In today's market, most hybrid ARM margins are set at between 2.75% and 3.00% over the one-year Treasury bill index rate. Borrowers, however, should pay attention to these features since there is no guarantee that interest rates won't be significantly higher when the fixed-rate period is up. And there is no guarantee that the borrower will be able to refinance, due to personal financial circumstances or real estate market conditions.
Therefore, having a hybrid ARM with a lower margin than industry standard is something that borrowers should look for. And it is something lenders should offer. Lenders who want to differentiate themselves among competitors - who also offer a wide array of fixed and ARM loans - should consider offering their mortgage options in an "a la carte" way, letting the customer decide what they want and need.
For instance, all borrowers do not need 30 years to pay off their loans, when 20 years might fit better into their financial plans. Alternatively, some borrowers might appreciate having a mortgage loan that amortizes over a 40-year term, if low monthly payments is their goal. Other customers might be better served by having a variety of monthly payment options from which to choose.
Flexible lenders can support choices that range from fully amortizing payments (which cover the principal and interest costs on the loan and fully repay the loan at maturity) to interest-only payment options.
Interest-only payment options are particularly attractive to customers who are:
- looking to maximize their cash flow,
- expecting their income to grow as their careers flourish,
- hoping to maximize a mortgage tax deduction or
- anticipating having more disposable income in the future.
These types of mortgage options actually broaden the way borrowers can think about their
mortgage loan. It's no longer just a way to buy a house, It's a tool to help manage their income, net worth and tax liability.
Another way for lenders to provide more choices is to offer ARM loans with different indexes and repricing frequencies. There are half a dozen or more ARM index options available today, including those tied to LIBOR (London Interbank Offered Rate), U.S. Treasury Securities and Certificates of Deposit.
Moving average features
Many of these indexes are offered with moving average features, as well as with varying maturities. For example, selecting a moving average index as opposed to a spot index can help smooth out mortgage payment changes for borrowers, thereby lessening the impact of the payment change when the mortgage loan reprices.
If a borrower selects a LIBOR or certificate of deposit index, they might find that the lender would offer an even lower margin than would be available on a one-year Treasury-indexed ARM.
Some lenders will reduce the margin even further if the borrower selects a more frequent repricing feature, i.e., an ARM loan whose interest rate reprices every one, three or six months instead of once per year.
Studies show that borrowers who understand and choose ARM loan products can come out ahead of those selecting generic fixed-rate mortgages. Whatever their motivation, customers will appreciate a lender who gives them choice instead of mandating a one-size only-product.
In addition to allowing customers the opportunity to customize their own mortgage program, offering innovative lending products is another way to capture a broader section of the market and deepen existing customer relationships as well.
One appealing new mortgage product is the pledged asset loan. This product evolved from the desire of financially sophisticated customers to find an alternative to liquidating their stock or investment portfolios to meet cash down payment requirements of lenders. It also allows borrowers to avoid capital gains taxes that may be incurred when selling investments to meet down payment requirements.
With a pledged asset loan, investors can finance a home in a way that allows their investment assets to continue working for their future. This means they do not have to disrupt their current investment strategy by selling investment assets in order to meet down payment requirements.
No cash needed
Instead, prospective borrowers can, with the cooperation of their broker and brokerage firm, use eligible brokerage account assets as collateral in place of a cash down payment. With a pledged asset loan, a customer can borrow up to 100% of the value of the home, and there are no private mortgage insurance costs required, as with traditional loans. This is another feature popular with borrowers.
This program can also be used to help a qualified family member, like a spouse or child, obtain financing for a home with no cash down payment. While pledged asset loans are not necessarily for everyone, they do provide a unique, innovative solution to a very common concern prevalent among sophisticated, financially savvy borrowers.
Lenders who make the conscious commitment to offer a comprehensive selection of loan programs and options that can be interchanged and tailored for each individual will create a strong value proposition for their customers.
Even if the customer opts for a standard program with no bells and whistles, they will still feel that they have been treated specially by virtue of the choices presented to them. And, for those sophisticated borrowers who consider their mortgage a financial tool - not just a loan - they will be enamored with a lender who can show them how to make their money work for them in ways they had not previously considered.
All it takes is a few happy customers to tell their friends, family and clients, and the power of the "word of mouth" referral will create its own momentum.
Larry A. Goldstone is president of Thornburg Mortgage Home Loans Inc. of Santa Fe, N.M. He can be reached at (877)862-2002.
This article was previously published in the March 2001 Issue of Secondary Marketing Executive
