Monday, 24 October 2016

The Crystal Ball Reveals Zero-zero Mortgages are the Next Big Thing

Although the Dodd-Frank Act of 2010 caps the mortgage origination fee at 3% for larger qualified mortgages (QMs over $100,000), the lenders are charging almost nothing. Current industry data shows that points and fees are below the half percentage level. The interest rates, as reflected in the annual percentage rates (APRs), are seen at historic lows of less than 4%.
After the subprime-mortgage crisis of 2007, the US economy is well on the road to recovery, with outstanding support from the Fed through their extended ‘Quantitative Easing’ (QE) program, from 2007 to 2014. The housing sector that had been totally crippled, and a major cause of the ‘Great Recession’, is showing signs of revival. Sales of mortgage loans and warehouse lending are on the rise.
Checks and balances have been brought into place to ensure the US economy never has to face a similar crisis. The Dodd-Frank Wall Street Reform Consumer Protection Act is an impressive piece of legislation brought in by the Obama administration in July 2010, to pre-empt and prevent any financial catastrophe of the nature witnessed after the crisis of 2007. Consumer Financial Protection Bureau (CFPB) has been tasked to prevent exploitation of mortgage borrowers by making it easier for consumers to understand the essence of mortgage agreements before completing the documentation process. Thus, mortgage brokers are prevented from leading borrowers to loans with higher interest rates and higher fees. The Act stipulates that mortgage originators cannot lead potential borrowers to loans that will yield the highest payment to the originators. The Act also stipulates that the lenders have to conduct due diligence of the prospective borrowers to reasonably ascertain their ability to repay such loans. Thus, as of now, over 98% of the residential loans are qualified mortgages (QMs).
After the enactment of the new Dodd-Frank legislation, competition among mortgage lenders has intensified greatly. This new legislation has brought in a great degree of transparency to borrowers. Thus, the lenders are vying to rope in ‘king customer’ with cut-throat offers of near to zero origination fees and points. For instance, a prime mortgage origination fee and points for a $100,000 loan in the mid-eighties would have cost around 2.7% or $2,700. Today a similar loan costs 0.5% or $500! The business objective apparently seems to be focused on getting hold of clients rather than the upfront Mortgage Technology processing fees and points. At the same time, no business can survive without making reasonable profits. So how do lenders make money to remain in business?
Mortgages are sold by the lenders in the secondary market to mortgage aggregators, who then through their tie-ups with Wall Street firms, convert them to mortgage backed securities (MBS). The lenders earn a premium on the interest from borrowers, but apart from that, loan origination and point fees also trickle in, although they are much lower compared to pre-subprime crisis days.
Transparency brought into the mortgage market by the Dodd-Frank Act has been a positive move. While interest rates, origination, and point fees are not much of a differentiator among the lenders, the lenders are doing all they can to woo borrowers, and that is showing up in the near-zero origination and points fees. The money and profits are being made from the back-end where the borrowers have little knowledge as to where and how their money is being plowed.