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Rates at 7% attract different types of borrowers, forcing lenders to rethink profit strategies

Industry experts believe mortgage rates will remain higher for longer, attracting borrowers who face life events but not “economic gamers“ to the mortgage market. In turn, this will force some lenders to think out of the box to attain profitability.

On Wednesday afternoon, the Federal Reserve announced its decision to maintain its short-term policy interest rate at a range of 5.25% to 5.5% for a sixth consecutive meeting, due in part to resilient inflation. Many monetary policy observers are betting on only one rate cut this year, far lower than the five or six cuts expected at the end of 2023. 

“The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%,“ the Federal Open Market Committee (FOMC) said in a statement. “In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage‑backed securities.“

The Fed’s moves have supported average mortgage rates at the mid-7% level, and there is no sign of relief soon. But industry experts say that mortgage origination volumes are expected to increase this year even in a higher-for-longer environment. 

Michael Metz, operations manager at V.I.P. Mortgage, estimates a 10% increase in total origination volume in 2024 compared to the previous year. The market is “still short on homes“ due to inventory problems, but buyers are not “off the table,“ he said. 

“More people are willing to sell their homes and buy a new one, even though they realize they are not going to get a lower mortgage rate, just because people are not worried about the market crashing anymore,“ Metz said. 

According to Metz, the mortgage market at this point can’t count on the “economic gamers“ — the people who buy a house due to advantageous home loan conditions or home price appreciation. But there are other borrowers facing life events — people who are divorcing, moving to another city, looking for more space or forming new families. 

“Anyone doing it for economic reasons is still holding off,“ Metz said. 

loanDepot CEO Frank Martell recently said the mortgage market cycle will be “longer and tougher than anybody expected,“ and not cured by a “50-basis-point reduction“ in rates. Stan Middleman, founder of Freedom Mortgage, also thinks that “interest rates are going to be higher for longer.“  

“In order to see mortgage rates drop more significantly, the Fed will need to see more evidence that inflation is slowing. An interesting question is whether that level of confidence could be achieved by the June meeting, which will benefit from two additional CPI (Consumer Price Index) readings,“ chief economist Danielle Hale said in a statement

“My expectation is that it will take longer, and that sets the Fed up for a late summer or early fall adjustment, and mortgage rates could follow suit.“

Eric Orenstein, senior director at Fitch Ratings, agrees. “Lower mortgage rates continue to feel more out of reach in this perfect storm of persistent inflation, rising Treasury yields and the Fed’s continued runoff of its MBS (mortgage-backed securities) holdings,“ he said.

Middleman believes “this year will look a lot like last year“ and “next year is going to look a lot like this year.“ To lenders, his message is “start making money on every loan.“

For Princeton Mortgage CEO Rich Weidel, reaching profitability means thinking differently about operations. 

Weidel cited Mortgage Bankers Association (MBA) data, which shows that independent mortgage banks (IMBs) have collectively been losing money for seven consecutive quarters. Revenue per loan for an IMB is about $10,376, but expenses are $12,485.

Lenders have followed the playbook of cutting costs and hiring more loan originators, a model that seems “to be broken,“ Weidel argues. “We are not making money by following conventional wisdom.“

Weidel performed a profit-and-loss (P&L) analysis on each of his loan officers and found that some LOs thought to be making a profit were some of the company’s most significant loss leaders. Meanwhile, other LOs he thought weren’t in the upper tier were doing much better for the company’s earnings. 

“What happens is that your more productive loan officers have a lower cost per loan but have the same rates as your less productive ones. We should be pricing these loans differently,“ he said.

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