Rates Up? So What! In HELs, ‘One Man’s
Ceiling Is Another Man’s Floor’
By building relationships in the secondary market,
banks can safely clear their warehouse loan inventory, creating new opportunities
for making more home equity loans.
By John C. Douglas
Given the current trend of moderately rising interest rates, many economists
expect the consumer tide to continue to turn toward home equity loans.
This is a reversal of previous months, when sharply lower interest rates
prompted consumers to turn to conventional refinancing options.
Coupled with increased consumer interest in home equity loans, consumer
interest turns up high in the Spring, when Winter ends and homeowners
begin thinking about home improvements.
An when interest rates rise, demand for new homes cools; more current
homeowners (not first-time homeowners) opt to retain their current home
and make improvements to existing structures.
All this means the time for capturing growth in the home equity lending
market is now.
Market advantages
In 2000, the growing home equity market offers lenders a number of diverse
advantages.
- A strong P&L opportunity to replace lost revenue from conventional first mortgage refinancing.
- An excellent cross-selling opportunity to sustain and retain mortgage customers.
- An avenue to re-direct bank resources, including market focus of loan priorities. Increased home equity activity can also help retain bank employees, who otherwise might be downsized as a result of lower demand for conventional refinancing.
- A home equity line of credit provides customers with additional tax benefits - something no longer available with conventional credit card debt increasing consumer attraction.
Consider the fact that in 1990, the U.S. home equity market topped out at $34 billion, a massive growth since the mid-1980s. But by 1997, the market had grown by sevenfold, cresting the $268 billion mark.
Now, the National Home Equity Mortgage Association forecasts that the market will have nearly doubled again by the end of 2000, conquering the $500 billion summit.
Not subprime only
The home equity lending environment has undergone stunning change. Once dominated by specialty financial operations dealing with less-than-perfect credit customers and charging very high interest rates, the market has transformed itself into offering mainline financial products that make considerable strategic sense for consumers.
It’s definitely not just a subprime market anymore. According to John Weicher, director of urban policy study for the Hudson Institute, the 1986 and 1989 tax and regulatory legislation unexpectedly created a platform - that included substantial consumer tax benefits - for conventional banks and mortgage companies to enter and shape the home equity market in the 1990s.
(Ed. Note: Weicher authored a nationally recognized book on the home equity market for The Hudson Institute, Indianapolis, Ind., a public policy research organization that forecasts trends.)
And indeed that was the case. Recent reports from the FDIC confirm that commercial banks are today the primary source of home equity loans. In short, the industry has recast itself as a strategic and legitimate service for consumers nationwide. Previously it had been regarded as essentially a "bottom-fishing market." In desperate financial problems, consumers typically turned to consolidation loans pegged to very high interest rates. HELs are now an accepted and highly useful consumer product.
For a number of reasons, this is good news for home equity lenders and secondary market investors in 2000.
First, the Mortgage Bankers Association estimates that only about 15% of U.S. homeowners have home equity lines of credit. This leaves a huge market available for home equity lenders. Second, a national study conducted by BANK ONE Corp. revealed that 40% of homeowners were unaware of the tax benefits available through home equity loans.
Further, the National Association of Home Builders reports that 44% of the nation’s net worth is in homeownership. From a consumer perspective, a home equity loan offers an attractive competitive blended rate coupled with their original mortgage for personal needs remodeling, college tuition or debt consolidation.
Rates drive growth
Certainly the market potential is there for strong growth for both the home equity lenders and secondary market investors.
Even greater potential exists as a result of the current trend of rising interest rates. For banks, mortgage companies and loan originators, the home equity product becomes an essential profitability tool to replace revenue streams lost from the drooping refinancing sector.
And the trend is already there. For example, between mid-1998 and mid-1999 in Wisconsin, mortgage refinance volume had fallen a remarkable 55%. At the same time, home equity loan volume had grown by 31%.
According to the MBA, this trend was matched nationally. Its July 1999 report showed that refinancing volume nationally had been cut in half over the same period the year earlier.
Clearly, if your financial institution focuses exclusively on conventional first mortgage and refinancing, 2000 is not looking good for increased profitability.
Secondary market role
In a growing market for commercial banks, where can the secondary market play a role?
Secondary market investors must continue to play a larger strategic role in furnishing capital. Many banks don’t possess the massive economies of scale needed for growth and their available capital is limited.
By developing partnerships with secondary market investors, brokers and bankers increase their profitability potential by seizing new opportunities for capital. Further, lenders can benefit from the increased array of funding options offered by secondary market investors permitting lenders to choose the level of risk most appropriate for their business.
In an industry that barely existed a little over a decade ago, secondary market investors create a huge strategic competitive advantage for lenders needing additional liquidity. Lenders can safely clear off their warehouse loan inventory by building relationships with secondary market investors, creating new opportunities for additional growth and profitability. Equally important, banks and mortgage lenders can reduce their risk-based capital portfolios by tapping into the multiple options offered by secondary market investors.
Because of loan quality requirements, the secondary market also indirectly improves the mortgage industry by forcing banks and mortgage lenders to run a clean and efficient operation before they can do business in the secondary market.
In the present environment, financial institutions – whether in the primary or secondary markets – have a tremendous opportunity for strong and increased growth.
The positive opportunities for lenders to leverage the multiple services offered by secondary market investors are there for the taking.
John C. Douglas is executive vice president - national sales & marketing manager for Bank One Home Loan Services. His 18 years of retail and wholesale residential lending experience includes a prior position as vice president and national sales manager for Citicorp Mortgage Inc.
This article was previously published in the March 2000 Issue of Secondary Marketing Executive.
