Thursday, February 17, 2022 | Jan Trifts
Significant increases in both interest rates and home values are changing the real estate market. Mortgage refinancing that has dominated lending is beginning to disappear, and higher home values have driven up home equity values. Now is the time for a renewed focus on home equity lending and particularly on home equity lines of credit (HELOCs).
Worries about the reemergence of inflation and a resurgence of COVID-19 cases are weighing on stocks and, in turn, driving up U.S. Treasury yields. The rate on the 10-year treasury has recently exceeded 2%.
Mike Fratantoni, chief economist at Mortgage Bankers Association, noted, “Inflation is running well above target, and the job market is booming. That is why it was no surprise that the Federal Reserve moved to accelerate their taper of Treasury and (mortgage-backed securities) purchases and signaled that the first-rate hike will be coming sooner rather than later. Moreover, the median (Federal Open Markets Committee) member now expects three rate hikes in 2022.” Fratantoni predicts the average rate on a 30-year mortgage will reach 3.5% by mid-2022 and 4% by late 2022.
Other leading economists have similar predictions. For example, Lawren Yun, chief economist at National Association of Realtors, forecasts mortgage rates to hit 3.7%, and Selma Hepp, deputy chief economist at CoreLogic, predicts rates will be closer to 3.4%. Whatever the exact outcome, the facts seem clear that mortgage rates are rising and, as they do, the refinance market is disappearing.
The second major change is the dramatic increase in home values that has occurred in recent years. Based on S&P’s CoreLogic Case Shiller National Index, home prices have risen on average by a third over the past three years and over 19 percent in the last year alone. Soaring home prices over the past year boosted home equity wealth to new highs. Research from CoreLogic shows the overall amount of equity in mortgaged real estate increased by $3.2 trillion in Q3 2021, an annual increase of 31.1 percent. The average annual gain in equity was $56,700 per borrower, which was the largest average equity gain in more than 11 years, and more than three times the gain from a year earlier.
Taken together, the disappearing refinance market combined with soaring home equity values provides an opportunity for financial institutions to refocus their efforts on home equity-based products. The best opportunity lies in HELOCs – specifically in hybrid HELOCs that offer borrowers the flexibility of a line of credit combined with the option to reduce interest rate risk by converting part of their line to a fixed-rate loan.
Over the past 15 years, there has been a steady decline in the importance of HELOCs to institutions participating in the Raddon Performance Analytics program. As shown in the chart below, in 2006 HELOCs accounted for 20.2% of loan portfolio balances and 5.2% of households that held home equity loans or lines of credit. In the most recent data from 2021, the percentage of portfolio balances had fallen to 9.8%, and the number of households with home equity products has fallen to 3.6%.
While the past trend has been downward, data from the February 2022 Raddon Research Insights, Lending Insights: The Rise of Buy Now, Pay Later suggests the trend is about to reverse. As shown in the table below, 7% of consumers anticipated applying for a home improvement loan over the next 12 months, and 4% and 5%, respectively, anticipated applying for a home equity loan or line of credit. In the Credit Driven and Upscale segments, the anticipated demand is even greater.
The hybrid HELOCs with a fixed-rate conversion option will become the new model for equity lending. Major banks, including Bank of America and PNC Bank, already offer this product, as do some Raddon clients. Hybrid HELOCs, sometimes also called fixed-rate option or convertible HELOCs, are typically structured initially as standard HELOCs. However, these loans also allow the consumer to convert a portion of the floating-rate line to a fixed-rate home equity loan with set blended principal and interest payments. Typical restrictions may include a minimum or maximum amount that can be converted to fixed rate and the number of fixed-rate conversions that may be in place at one time.
Hybrid HELOCs offer important benefits to consumers, but how popular are they? And what benefits can financial institutions that offer them expect? Raddon research suggests the product is not yet well understood in the marketplace. In the February 2022 Raddon Research Insights study, we asked consumers, “If you were to take out a home equity loan or home equity line of credit in the next two years, what type would you prefer to open?” Only 8.9% selected the hybrid option, compared to 42.3% for a traditional nonhybrid HELOC and 36.8%for a fixed-rate/fixed-term home improvement loan. Rather than indicating low potential demand for hybrid HELOCS, this response indicates a lack of consumer knowledge about an emerging product. There is a great opportunity to build demand through marketing and consumer education about these products.
The experience of one Raddon client provides a glimpse into the potential gains. This client is a large credit union located in the northeast U.S. and has offered the hybrid HELOC for several years. As seen in the table below, Raddon Performance Analytics statistics show the institution has benefited greatly from offering hybrid HELOCs.
Market penetration of hybrid HELOCs is 10.5%, in the top 1% of all institutions in the Raddon Performance Analytics program, and well above the average participation rate of 3%. Similarly, the average balance for hybrid HELOCs is almost 75% greater than with nonhybrid products. The combined effect of stronger penetration and higher balances is dramatically higher account and household profit.
If you’re considering offering a hybrid HELOC, the first step is education – for both your accountholders and your frontline employees. Marketing messages must be developed with the expectation that many of those you reach will not be familiar with the hybrid product and its benefits over the traditional HELOC. Equally important to helping potential borrowers understand the product is being sure your own employees know it well. Frontline staff must be especially knowledgeable about the product to be able to answer questions and explain the benefits to potential borrowers encountering hybrid HELOCs for the first time.
The real estate lending market is changing dramatically, and the next best opportunity may lie in home equity lending and specifically the new hybrid HELOC. Your biggest competitors are already offering hybrid products, and the early experience shows that these products offer opportunities to build market penetration, account balances and profitability.