Against the Current – theMReport.com
With refinancing volumes expected to fall in 2021, originators are looking for alternative ways to generate income — and home equity loans (HELs) have become one of the best options.
Rising home values and a strengthening economy are the obvious reasons for this. According to a recent CoreLogic report, US homeowners realized a 16.2% increase in their home equity over the past year, for a total gain of more than $1.5 trillion, compared to the average homeowner’s $26,300 increase recorded. A growing number of homeowners will use this equity for renovations, paying for a child’s college tuition, or to consolidate debt and lower their monthly payments.
In his 2020 Home Equity Lending Study The Mortgage Bankers Association, released last August, forecast that HELs would rebound in 2021, with volume up 9% from 2020.
Another reason the home equity market is expanding is investors’ resurgent appetite for second-tier loans, which have all but disappeared in the early months of the COVID-19 pandemic.
state of the capital markets
Originators have good reason to watch home-equity loans now that funding volumes continue to fall. Mortgage rates are likely to rise to 3.6% by the end of 2021, according to the latest projections from the MBA. As interest rates rise, margins on front-end products will also fall. Thanks to low inventories and rising home values, not only do homeowners have more equity in their homes, but secondary lien capital markets have reopened, fueling the creation of new home products. However, not every lender could benefit from it.
There are currently only four or five major players in the home equity space. While lenders can make $10,000 on each purchase loan made, they only make between $1,000 and $3,000 on home equity loans, so many don’t really pay much attention to this market. In fact, some banks have withdrawn from the home equity market entirely since last year.
Another reason fewer lenders are offering home equity products is that this market isn’t easy to break into. The capital for HELs and home equity lines of credit (HELOCs) comes from two different sources: Main Street — that is, credit unions and big banks, which generally hold these loans on their balance sheets — and Wall Street, which is a very fragmented market and difficult to crack.
At the beginning of the pandemic, the capital market side completely exploded and investors pulled out of everything but agency products. As the economy started to recover, investors returned to where things are now somewhat normalizing. While investor demand for second liens hasn’t been incredibly high, the rise in interest rates should boost demand, which will increase the availability and supply of second liens.
Several large home equity securitizations and HELOC loans have taken place since the market rebounded. In September, we saw the largest HELOC-backed securitization since the last real estate crisis, totaling $308 million. In December, we contributed to a $146 million securitization of HELs into the market.
Attractive yields are other factors fueling investors’ appetite for secondary deposit products. Second lien loans are more of a credit product, so they are not matched to 10-year bonds like purchase loans. For example, for true second-lien loans, one would look at shorter-dated bonds such as seven-year bonds, which are currently yielding 1.4%. In the two securitizations mentioned above, the yield on A-1 loans – the large tranche in both deals – was 3.0% for HELs and 3.5% for HELOCs.
Investor concerns remain
Investors are increasingly comfortable with the idea of things returning to normal, but many unknowns remain. One of them is the launch of the COVID-19 vaccine, which looks promising at the moment. That could change if not enough people get vaccinated and we see another big spike in cases in the spring and summer months. Many investors are still waiting to see what impact this will have on jobs, the stock market and the broader economy.
Another positive impact on investor prospects was the government’s proactive response to the COVID-19 pandemic. Allowing borrowers to suspend mortgage payments for six months or more and then allowing them to modify their loans has kept massive defaults at bay. In the meantime, stimulus checks give many people who can afford to keep making mortgage payments the opportunity to pay down debt and prop up their financial position, giving them better credit risk.
To some extent, investor optimism about second mortgages follows the reopening of the economy. The biggest concerns investors have with home equity products are the volatility of home prices and the potential for borrowers to stretch their budgets. However, today’s market doesn’t really resemble what it looked like before the global financial crisis of 2008.
There are now appraisal rules that didn’t exist before and the income requirements are also much stricter now. Meanwhile, home values have also risen steadily during the pandemic as people who previously lived in apartments and townhouses began looking for more single-family home space.
Seize the opportunity
Along with increasing investor demand for home equity products, second lien loan origination is becoming easier and easier. Lenders specializing in home equity products have invested in technology to streamline the process and make it easier and faster for homeowners to access cash in their homes. Automated Appraisal Models (AVMs) can also be used to appraise the value of cheaper homes, further shortening the creation process.
The reality is that there aren’t many good second lien players changing the market, but the ones that do exist have the opportunity to push things further. Currently, smart home equity investors shore up their investor partnerships and ensure their products fit the long-term investment profile of their equity partners.
For originators, the bottom line is that the market is changing, and in order to grow the business, they need to sharpen their pencils and develop an action plan for a higher interest rate environment. For most, home equity loans are the best options, allowing borrowers to maintain the same low interest rate as their first mortgage while getting the money they need. And while most home equity loan originators are brokers, there are growing opportunities for home equity loan originators in this space as well.
When peanuts Creator Charles M. Schulz once wrote, “Life is like a 10-speed bicycle. Most of us have equipment that we never use.” For originators looking to grow their business, it may be time to take advantage of those extra aisles — starting with an experienced home lender with the capital partners and a track record that makes borrowing as easy as riding a bike.