As the Federal Reserve increases interest rates in an attempt to lower inflation, a confluence of factors point toward home equity growth opportunities for financial institutions. With dramatic changes in the mortgage market, soaring home values and a shift in market share among institutions competing in this space, what can your organization do to win its fair share of the market opportunity?
 

Dramatic Changes in the Mortgage Market

Rising interest rates mark the unofficial end to the refinance boom initiated at the start of the COVID-19 pandemic. With 30-year fixed mortgage rates having hovered in the 3% range for much of 2020 and 2021, homeowners refinanced their existing mortgages at unprecedented rates. Refinanced mortgages accounted for 64% and 59% of one- to four-family mortgage originations in 2020 and 2021, respectively. Based on projections from the Mortgage Bankers Association, and with rates increasing, this refinance share is expected to level off at 33% in 2022 and 26% in 2023. In short, the majority of qualified homeowners for whom it would be advantageous to refinance have likely already done so in the last two years. 

1-4 Family Mortgage Origination Activity

Source: Mortgage Bankers Association, May 2022 Mortgage Finance Forecast

Another byproduct of the two-year refinance mania is its impact on outstanding home equity balances. At the end of 2019, the Federal Reserve reported $501 billion in outstanding home equity balances. This total had dropped to $396 billion by the fourth quarter of 2021. At least part of this 21% decline can be attributed to consumers consolidating debt and rolling their equity balances into their refinanced first mortgage.
 

Home Equity Usage Has Not Rebounded Since the Great Recession

Although the decline in home equity balances accelerated during the pandemic-initiated low-rate environment, it is not a new trend. In fact, ever since the sharp and unsustainable increases in home equity balances in the years leading up to the financial and housing crisis in 2008, home equity balances have steadily declined. While Great Recession–era charge-offs, declining home values and overleveraged homeowners contributed to the initial drop in home equity balances, the ongoing decline suggests there may be more at play in both lenders’ and borrowers’ relationships with home equity loans.

Home Equity Loans (all sectors)

Source: Board of Governors of the Federal Reserve System (US)

Top Three Major Banks Have Significantly Reduced Their Exposure to Home Equity Credit

Part of the steady decline since the Great Recession includes a significant shift in the home equity market share controlled by the three largest retail banks. Bank of America, Wells Fargo, and Chase collectively accounted for 40% of all outstanding home equity loan balances in 2010. The same equity market share is only 19% today. 

Total Home Equity Loan Balances

Source: FDIC, NCUA; Top 3 Major Banks are Bank of America, Wells Fargo, JPMorgan Chase

Whatever the reasons for this strategic shift in the loan portfolio mix, it represents an opportunity for other financial institutions to fill the gap. While other banks in totality follow a similar trend line as their big bank brethren, credit unions as a group experienced a 28% increase in overall home equity balances between 2013 and 2019, offsetting the 26% decline seen during the five years prior to 2013. Credit unions have not been immune to the decline in balances during the pandemic though. Despite strong balance growth and increased market share over the last decade, data from credit unions participating in Raddon’s Performance Analytics benchmarking program shows that equity lending has played a diminishing role in loan operations. This is evidenced by the 5.2% of credit union member households that had an equity loan in 2006 (pre–Great Recession) dropping to 4.8% in 2011 (post–Great Recession), 4.1% in 2016 (prepandemic) and 3.6% in 2021 (postpandemic onset). In other words, credit unions may have experienced balance growth, but it did not exceed the pace of household growth.

Hot Real Estate Market Must Cool Eventually

A combination of low rates and an imbalance in housing supply and demand driven by demography changes in the U.S. has created a red-hot real estate market in many areas of the country. Home values have soared as demand exceeds supply and homebuyers capitalize on the low-rate environment to stretch their mortgage dollars further. The $295k median home price for existing homes in 2020 rose to $344k in 2021 and is expected to reach $373k in 2022 according to projections from the Mortgage Bankers Association. Median prices for new homes follow a similar trend, going from $335k in 2020 to $427k in 2022. As we know, all good things (at least for sellers) must come to an end, and the home price appreciation is expected to taper off a bit in 2023 and 2024, as shown in the chart below.

Median Home Prices (in thousands)

Source: Mortgage Bankers Association, May 2022 Mortgage Finance Forecast

Capturing Your Fair Share of the Opportunity

Although housing values will not continue to rise at this pace indefinitely, homeowners in most markets right now have seen a sharp increase of equity in their homes. Accounting for the cautionary tale of contributing factors to the Great Recession, responsible home equity borrowing and lending can benefit both consumers and lenders. For your institution to capture its fair share of the opportunity, evaluate your equity offerings and the methods you use to market them to different segments of your base that may borrow for different reasons. The first component of this relates to product design. This previous Raddon Report article addresses some of the appeal behind the hybrid HELOC with a fixed-rate conversion option.

The second component is to then utilize data to not only identify strong targets for equity offers but also better tailor those offers for the recipient. For example, the profile of, and offer to, an individual who may benefit from a home equity loan to help consolidate other debt may be very different from that of an individual who needs to pay for college tuition or one who simply wants to remodel their kitchen. Personalizing the offers accordingly can help differentiate your offer from others.

The final component of a successful equity lending strategy entails an honest evaluation of your equity loan application and origination processes. Without sacrificing risk mitigations or underwriting standards, are there ways you can make the process easier and more efficient for both the borrower and your institution?

Presenting strong product design, leveraging data for personalized targeted marketing, and reducing friction in the application process will position your institution to capitalize on profitable home equity growth during this perfect storm of opportunity.