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   ARTICLE   |   From Scotsman Guide Residential Edition   |   June 2011

Predicting the Future of Mortgage Products

Adjustable rates could rule as lenders search for new lending solutions

Predicting the Future of Mortgage Products

Every week or two, we read something new about how the mortgage industry will soon be shaken to its core. Although these reports frighten some of us, they should at least concern us all. Whether you're a broker, banker, loan officer or wholesale account executive, it's safe to say that uncertainty in the mortgage industry will persist for the remainder of 2011 and beyond.

With so many questions swirling about, now is a great time to consider an array of possible futures. Here's a speculative look at how the U.S. mortgage market could develop in the months and years ahead.

Fixed rates will increase

With the role of Fannie Mae and Freddie Mac likely to decrease dramatically and the cost of securitization poised to increase, fixed mortgage rates soon will move upward.

Are we headed back to the days of 8.5 percent? Maybe.

Could we go even higher? Perhaps.

Regardless of how high fixed rates climb, more borrowers will consider adjustable-rate mortgages (ARMs) as fixed rates leave their record lows. It likely won't be long before non-fixed-rate mortgages regain significant market share.

Less government lending

Without a doubt, Fannie, Freddie and the Federal Housing Administration (FHA) will pull back their involvement in the mortgage markets. It's possible the effects of those changes are already visible.

Combined, mortgages purchased by Fannie Mae and Freddie Mac and those insured by the FHA made up about 90 percent of all residential lending in 2010.

If the total dollar amount is cut in half, the private secondary market and portfolio lenders will re-emerge in a big way. Chances are, they'll require at least 90 percent loan-to-value ratios (LTVs), as well. No matter what happens, different players must play larger roles in the lending arena. A mortgage market subsidized heavily by the federal government isn't sustainable.

We'll copy the U.K. …

Britain has a mortgage-backed securities market, but its federally backed entity is essentially a nonplayer, only buying mortgage pools in times of dire need. This means either a lender or institutional investor must believe it's going to make money on the mortgages it approves.

Here's a rundown of some typical U.K. mortgage products:

  • Five-year discount mortgage: For the first five years, the mortgage rate is the Bank of England Base Rate (BOEBR) minus a small discount. After that, the rate becomes the bank's standard variable rate. These loans are adjustable.
  • Easy-step mortgage: This has a complicated and variable mix for the first two years. After that, the rate becomes either the BOEBR or the bank's standard variable rate. These loans are adjustable.
  • Base-rate tracker mortgage: The rate is just below the BOEBR for a determined amount of time (two to five years). After that, the rate becomes the BOEBR plus 0.75 percent. These loans are adjustable.
  • Base-rate tracker term mortgage: The rate is slightly greater than the BOEBR for the entire mortgage term. These loans are adjustable.
  • "Fixed-rate" mortgage: This mortgage is similar to our hybrid ARMs and includes a fixed rate for the first two, three or five years. After that, the rate typically changes to BOEBR plus 0.75 percent.

As you can see, U.S.-style fixed-rate mortgages are uncommon in the U.K., where hybrid ARMs instead account for significant market share. In addition, amortization terms often top out at 25 years. The shorter terms yield more safety for lenders and force borrowers to incur more risk and monthly obligations. Don't be surprised if lenders in the U.S. begin to adopt mortgage products similar to those described here.

… Or Canada

Canada thus far has largely averted the housing disaster of the past three years, and many of the mortgages in that country come with borrower prepayment penalties. An increase in the prevalence of such penalties could come to the U.S. soon.

Here's a quick look at some Canadian mortgage options:

  • "Fixed-rate" mortgage: Amortization term of as many as 25 years. The fixed-rate portion is between six months and 10 years. After that initial fixed term, the borrower must either pay off the loan or refinance.
  • Variable-rate mortgage: The mortgage rate is always the same as the bank's prime rate. These loans are adjustable.
  • Total-equity mortgage: This product was recently introduced by at least one bank and combines a mortgage loan with a borrower's checking account and in some cases other loans (e.g., auto). Borrowers can split their mortgage into two or three different types, each with different terms and rates.

These products helped keep Canada from a major downturn. You may be offering something similar soon.

•  •  •

Whatever happens in the next few years, mortgage brokers and loan originators should steady themselves for change. Increased interest rates, strict documentation requirements and LTVs of no more than 90 percent seem likely. So does a new wave of adjustable-rate lending products.

Industry professionals who plan properly can create distinct advantages for their business and better adjust to the coming changes, whatever they may entail.


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