Against the Tide

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With refinancing volume poised to fall in 2021, originators are starting to look toward alternative means of generating revenue—and home equity loans (HELs) have become one of the best options.  

Rising home values and a strengthening economy are the obvious reasons why. According to a recent CoreLogic report, U.S. homeowners realized a 16.2% increase in home equity last year, representing a combined gain of more than $1.5 trillion, while the average homeowner saw an increase of $26,300. A growing number of homeowners will be using that equity for home improvements, paying for a child’s college tuition, or to consolidate debt and lower their monthly payments.  

In its 2020 Home Equity Lending Study released last August, the Mortgage Bankers Association predicted HELs would rebound in 2021, with volume rising 9% over 2020.  

Another reason the home equity market may expand is rebounding investor appetite for second-lien loans—which practically vanished in the early months of the COVID-19 pandemic.  

State of the Capital Markets 

Originators have a good reason to pay attention to home equity loans now with refinance volumes continuing to decline. According to the MBA’s latest projections, mortgage rates are likely to climb to 3.6% by the end of 2021. As rates rise, margins on front-end products are going to drop as well. Thanks to low inventory and rising home values, homeowners not only have more equity in their homes, but the capital markets for second liens have opened back up, which is fueling the creation of new home equity products. However, not every lender has been able to take advantage.  

Currently, there are only four or five major players in the home equity lending space. While lenders can make $10,000 for every purchase loan originated, they only make between $1,000 to $3,000 on home equity loans, so many aren’t really paying much attention to this market. In fact, some banks have dropped out of the home equity market completely since last year. 

Another reason fewer lenders offer home equity products is that it’s not an easy market to break into. Capital for HELs and home equity lines of credit (HELOCs) comes from two different sources: Main Street—that is, credit unions and large banks that generally keep these loans on their balance sheets—and Wall Street, which is a very fragmented market and tricky to crack.  

At the start of the pandemic, the capital market side blew out completely and investors stepped away from everything except agency products. As the economy began to rebound, investors started coming back, where things are now somewhat back to normal. While the demand from investors for second liens hasn’t been incredibly high, the increase in rates is likely to push up demand, which is going to increase the availability and supply for second liens. 

Since the market’s rebound, several sizable securitizations of home equity and HELOC loans have been made. In September, we saw the largest securitization backed by HELOCs since the last housing crisis, totaling $308 million. In December, we contributed to a $146 million securitization of HELs to market.  

Other factors driving investor appetite in second-lien products are attractive yields. Second-lien loans are more of a credit product, so they don’t track against 10-year bonds the way purchase loans do. For true second-lien loans, for example, one would look at shorter-term bonds like seven-year bonds, which are 1.4% right now. In the two securitizations mentioned above, the yield for A-1 loans—the large tranche in both deals—was 3.0% for HELs and 3.5% for HELOCs.  

Investor Concerns Remain 

Investors are growing comfortable with the idea that things are returning to normal, but many unknowns remain. One is the COVID-19 vaccine rollout, which currently looks promising. That could change if not enough people get vaccinated and we see another huge spike in cases during the spring and summer months. Many investors are still waiting to see what the impact will be for jobs, the stock market, and the overall economy.  

Another positive impact on investor outlook has been the government’s proactive response to the COVID-19 pandemic. Letting borrowers suspend mortgage payments for six months or more and then giving them the opportunity to modify their loans has kept massive defaults at bay. Meanwhile, stimulus checks are giving many people who can afford to keep making mortgage payments an opportunity to pay down debt and shore up their financial position, making them better credit risks.  

To a certain extent, investor optimism toward second mortgages is tracking with the reopening of the economy. The biggest concerns investors have with home equity products are home price volatility and the possibility that borrowers are overstretching their budgets. However, today’s market doesn’t really resemble how it looked before the global financial crisis of 2008.  

There are now rules about appraisal values that were not in place previously, and income requirements are much more stringent now as well. Meanwhile, home values have steadily increased even during the pandemic, as people previously living in apartments and townhouses began looking for more space with single-family homes.  

Tapping Into the Opportunity  

In addition to increasing investor appetites for home equity products, originating second-lien loans is getting easier. Lenders that specialize in home equity products have been investing in technology to streamline the process and make it easier and faster for homeowners to access cash in their homes. Automated valuation models (AVMs) can also be used to assess value on lower priced homes, which shortens the origination process even further.  

The reality is there are not many good second-lien players changing the market, but the ones that exist have an opportunity to take things further. Right now, smart home equity lenders are shoring up their investor partnerships and making sure their products match the long-term investment profile of their capital partners.  

For originators, the bottom line is that the market is shifting, and to grow business, they’ll need to sharpen their pencils and come up with an action plan for a higher rate environment. For most, the best options are home equity loans, which allow borrowers to keep the same low rate they have on their first mortgage while getting the cash they need. And while most home equity loan originators are brokers, there are also growing opportunities for correspondent lenders in this space. 

As Peanuts creator Charles M. Schulz once wrote, “Life is like a 10-speed bicycle. Most of us have gears we never use.” For originators looking to grow business, it might be time to use those extra gears—starting with an experienced home equity lender with the capital partners and track record of making the borrowing experience as simple as a bicycle ride. 

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