A Glimmer of Hope – Mortgage Refinancing in the Wake of Coronavirus

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The financial markets have experienced unprecedented levels of volatility resulting from the Coronavirus pandemic. These swings in the market have prompted equally unprecedented responses from the Federal Reserve and U.S. Treasury with the aims of providing relative stability to the financial system. I have written extensively about the responses taken by the Fed over the last month, providing mostly overviews and critiques of certain credit facilities. Moving forward, I’d like to highlight something that has emerged as a financial silver lining amongst the chaos – increased utility from and demand for mortgage refinancing.

A significant result of the turmoil we’ve seen in the financial markets has been rate cuts. The Fed cut rates to near zero at the beginning of the pandemic to quell the market and incentivize borrowing. The lower rates have generated a boon in demand for mortgage refinancing. According to the Wall Street Journal average jumbo loan rates dropped to their lowest levels since 2011 – 3.58%. Given the current circumstances, it is likely that rates will remain low. Excessive demand for mortgage refis may result in minor rate hikes, but in general the incentives to refi will remain intact.

Moreover, given the combination of massive losses of income, low rates, and a boon in home equity over the past 10 years, families and individuals will be looking to cash in on the equity they’ve accumulated. Home equity can provide a much needed buffer for households that have experienced a reduction or complete loss of income. Fortunately, given the low rate environment and demand for mortgage backed securities (MBS) enhanced by the Fed, households find themselves in an opportune position to access the capital they need. However, the current state of affairs presents a dynamic situation. Prospective borrowers should familiarize themselves with potential disruptions in the process as well as easy to make, but avoidable mistakes. A few examples of each will be presented below.

Potential Disruptions

I read a great article from Brookings that explored several potential disruptions and also laid out a set of policy solutions for each. I highly recommend reading it if you’re interest in more than a cursory overview of the mortgage space. For the sake of this post, I’ve isolated the two disruptions I considered to be the most important for prospective borrowers to be aware of – verification of employment and closing.

First, mortgage refis currently require some form of employment verification; this is a difficult requirement to meet in the current environment when so many employers have been forced to shut down in the midst of the pandemic. Fortunately, Fannie Mae and Freddie Mac have provided some flexibility to the situation by allowing employers to verify employment status via email. Moreover, this requirement can also be met with a paystub or bank statement and the lender can wait to obtain verification up to loan closing. This step is key and all lenders will want to maintain it as part of their underwriting process to some degree. Moreover, Fannie and Freddie have both required lenders to engage in due diligence to ensure continuity of income during the pandemic as a condition to guarantee the loan. Conventional lenders will have more flexibility to address repayment capacity, but since a significant portion of mortgage lending incentives are provided through Fannie and Freddie, this may present a significant pitfall for prospective borrowers. This is particularly true for those who are self-employed.

Second, the closing process for these loans is complicated in the current environment because many homeowners will be unwilling to allow a notary into their home to physically execute closing documents. Conversely, many notaries are likely to resist entering a stranger’s home. A majority of states do not allow e-notarizations, but fortunately this is changing. Currently, 23 states allow for virtual signings, with New York being the most recent addition as of March 20th.  Additionally, there are an increasing amount of Fintech lenders adopting the e-notarization standard as the default for closing loans – Figure Technologies is an excellent example.

Mistakes to Avoid

The two most important considerations prior to initiating a mortgage refi are getting appraisal ready and making sure your credit situation is lean. First, make sure that your home is appraisal ready before engaging a lender. Since the appraisal will ultimately determine how much equity you can withdraw from your house, it is imperative that everything is in order prior to ordering an appraisal. If you’re considering home improvements or in the midst of completing them, make sure they are completed in advance. The house should not be under construction at any point during the appraisal process. Ultimately, the key is to ensure your home is as immaculate as possible to maximize the valuation at the time of refinance.

Second, make sure your credit situation is pristine. Do not open a new auto loan, line of credit, etc immediately before or during the mortgage process. New debt creates several issues that can impact your ability to qualify. This is especially important during the pandemic, as repayment capacity will be heavily scrutinized. Moreover, as lenders gear up to process a slew of refi requests, they will inevitably run into problems with capacity. In normal times, lenders would just hire and train new loan officers, but the pandemic has inhibited hiring in a majority of sectors, not just mortgage lending. As capacity is stretched thin, lenders will likely place a premium on borrowers with the best credit situation. The more you can do to enhance your repayment capacity, the better.

This wraps up my post on mortgage refinancing in the wake of Coronavirus. As always, if you found this information valuable please like, share, and subscribe to my content.

TALF: A Looming Deficit

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Last week I published a blog post that outlined the credit facilities introduced by the Federal Reserve to address the impact Coronavirus has had on the financial markets and real economy. My introduction to that post did not shy away from the fact that I had some reservations and misgivings about the decisions made by the Fed. I stated that I would expand on these misgivings in more detail in future posts, so this week I will follow through on that statement. I am going to discuss issues I have with three credit facilities in particular in separate posts: Term Asset-Backed Securities Loan Facility, Primary Market Corporate Credit Facility, and Secondary Market Corporate Credit Facility. I will begin with TALF.

The Missing Market

I’d like to start off by stating that I understand the impetus for TALF and believe it will provide stability to lenders and allow them to support borrowers through the crisis. The rationale is essentially that this will allow lenders to continue extending credit since the Fed will step in and maintain the market for asset backed securities. However, as American Banker has pointed out, the 2020 version is ill equipped to fully address the existing market for these loans. This credit facility neglects a significant aspect of the contemporary market – the prominence of unsecured consumer loans.

According to Kroll Bond Rating Agency (KBRA), approximately $10 billion of consumer loan backed ABS was originated in 2019. These loans were primarily originated by nonbank lenders, also known as “fintechs” (financial technology companies). These loans are typically considered investment-grade (i.e. they have a higher interest rate associated with them in lieu of collateral and therefore provide a higher yield to investors willing to purchase them). The problem here is that these tranches of ABS loans are not eligible under the existing TALF provisions, hence excluding a significant portion of originators from relief. It is likely that this will in turn lead to restricted credit access for millions of consumers.

Demand for unsecured consumer installment loans has expanded rapidly over the last 10 years, with volume more than doubling. The St. Louis Fed published an article stating that approximately 78% of consumers have utilized these loans in one form or another, most often for the purpose of refinancing existing debt. These loans also play a significant role in small business lending – which I can speak to anecdotally. Small business owners will often front initial start-up costs with personal loans from companies such as Prosper or Kabbage. Once they become “bankable” (i.e. they have a more stable track record operating as a business) they will seek to refinance these installment loans with a commercial loan at a lower rate.

Many fintechs fund their lending operations through the capital markets. They originate the aforementioned installment loans and then package them as investment-grade ABS products for sale to investors. As a result of the uncertainty stemming from the pandemic, the market for these riskier, higher yield ABS products has started to dry up. Since many of these fintech companies rely on the capital markets to fund their operations, the absence of prospective buyers for these tranches will force them to rely on their balance sheets to originate new loans, or halt lending for an undetermined period. Given the business model associated with most fintechs, the latter appears to be the more likely outcome. This will of course lead to a large swath of consumers being cut off from much needed credit.

Conclusion

Without access to reasonably priced credit, many consumers will be left without viable credit options. The alternative for many will be to accept credit on more expensive terms at a time when they will likely be unable to afford it. Unfortunately, given the dynamics of the pandemic, it is difficult to think of a viable solution to the aforementioned that wouldn’t have to come from TALF. This is especially true, in my opinion, given the issues we’ve seen with the roll out of PPP lending and individual stimulus checks.

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