The 100-Years Refinance (Exaggeration Intended)

My colleagues and I talk frequently about the coming changes in mortgage lending. The 100-years refinance (exaggeration intended) cycle will end this year or next. In its place is likely to be the most sustained purchase-money market since the 1950s through the 1960s. There are signs of this already. One headline last week in Housingwire read ‘75% of Americans would rather buy now than later’. No doubt they want to take full advantage of the lowest rates in history before home prices rise too much further.

You know this. Everyone knows this. Helping people finance home purchases for the next decade or so is some of the most rewarding work mortgage lenders will undertake during their careers. Many first-time homebuyers will get their homeownership start in the next few years. Our chances to work with them for a lifetime begin now.

There’s a potentially dark side to the coming market changes. Rates will rise. You know this, too. What you might not have thought much about, however, is how much they will rise or for how long, and more importantly, what will the impact be on your secondary marketing pipeline. Start with this fact: rates today are at their lowest point since 1941. Since 1941 rates trended upward until 1985 when the 10-year Treasury rate peaked above 14%. From that point rates began their downward trend, bringing us to where we are today, back to where we were 70 years ago.

History repeats itself. Looking way, way back in history rate trends are easy to spot. Since the late 1800s two 60-year rate cycles are apparent. Rates tend to rise for 25 to 30 years and then fall for the next 25 to 30 years. The cycle then starts all over again for the next six decades. No one can say for sure this will happen again, though the safe bet would be to assume a long-term upward trend is about to begin.

Why this is important and why this is the darker side of mortgage lending has to do with one of the ways we make our money as mortgage lenders. Recording secondary market profits, the gain made when mortgage loans are sold, relies on how well the vagaries of interest rate movements are managed. A secondary market truism is that it is relatively easy to make secondary market profits as rates trend downward. Hedging pipelines is seen as largely unnecessary. It’s also expensive and reduces profitability. Hedges protect against upward movements in rates. Rates haven’t moved consistently upward in a long time. What do many lenders do in these conditions? Not much. Take a lock from a borrower; float the rate with their investor. Chances have been rates will have moved down by the time the loan closes. This results in a bigger gain. Everyone is happy.

Everyone is not happy when rates spike up, which they will inevitably do. Start with the same scenario. Borrower locks their rate; lender floats the lock with their investor. Only this time rates spike up 100 basis points. Rather than a tidy profit the lender records a significant loss. Multiply that loss by the number of uncovered loans in the pipeline. The loss becomes a figure to be reckoned with, one that is easy to explain though impossible to defend. This very scenario played out on Black Monday in 1987. Mortgage companies racked up huge losses. Some closed their doors permanently. How did they get caught? Easy. Rates had been trending steeply downward for several years. Until they didn’t.

Call me Chicken Little. But the sky isn’t falling; it isn’t even a bit lower. Look at it this way. One of my colleagues is fond of reciting the 6Ps: Proper Preparation Prevents Pathetically Poor Performance. Be prepared for when rates rise. Look at your pipeline management practices, tools and hedging strategies now. Good secondary market professionals make money no matter which direction interest rates are trending. Good secondary market professionals practice the 6Ps.