Editor's note: This story was originally featured in the February issue of MReport, out now.
There’s no doubt the 30-year fixed-rate mortgage is the American housing market’s most used—and most offered—product. But with more and more millennials hitting the scene and buyer demographics constantly in flux, some lenders are left wondering: Is it time to shake things up a little?
The 30-year Looms Large
It’s easy to understand the popularity of the 30-year mortgage. For lenders, it offers an easy way to get new buyers in the door, and for consumers, it provides a reliable, consistent monthly payment that keeps household finances in check over the course of the loan. As Todd Jones, President of Retail Mortgage at BBMC Mortgage, puts it, “In the big scheme of things, it’s most beneficial to the borrower to have a lower, fixed payment they know will not change for a considerable period of time.”
According to Peter McCarthy, Head of Mortgage at PNC Bank, this stability is crucial—particularly for first-time buyers.
“Historically, low rates have driven borrowers to the fixed-rate option,” McCarthy said. “The fixed-rate mortgage removes payment uncertainty, making it an effective product for the majority of borrowers—especially first-time homebuyers.”
Kristy Fercho, Head of Mortgage at Flagstar Bank, says that stability is especially important for borrowers who intend to stay in their home long-term. “I think you have to think about the house, for the majority of people, as being the largest financial investment they will ever make,” Fercho said. “To really have a product that can go with them through their growing income and different life phases, I think that is why it has been the product of choice.”
Despite its popularity though, not all agree that the 30-year is the best fit for today’s buyers. According to Taylor Salditch, VP of Marketing at Better Mortgage, while the 30-year might feel safe, it’s not always the best bet.
“I think that the 30-year fixed-rate, 20-percent-down, traditional mortgage product feels the safest and feels like the thing they’re supposed to do,” Salditch said. “It has social-proofed itself to be the most predominant loan product in the market, even if that’s not the best financial decision to make. People feel risk-averse when it comes to selecting a mortgage, particularly if it’s their first time.”
Salditch says first-time buyers often choose 30-year products because they’re unfamiliar with other options that might be out there. More experienced and refinance buyers tend to go with adjustable-rate mortgages or shorter-term options.
“I don’t necessarily think that the 30-year mortgage is the best for everybody,” Salditch said. “I think mortgages are not one size fits all, and if you are a millennial homeowner or a first-time homebuyer and you’re looking to get a starter home, and you know that two bedrooms will work for you in the short-term, but in the next five or seven years, you could see yourself selling that property and moving into the suburbs, getting a larger home, then an ARM might be just as good, if not better. It could help you save over the life of that loan.”
For buyers choosing ARMs or more complicated products, Erik Schmitt, Product Executive at Chase Mortgage, has a few words of caution.
“I think it’s really critical the customer fully understands the risk they’re assuming with those products,” Schmitt said. “They need to understand the risk they’re assuming when they get into a non-30-year product. Given what we learned from the crisis, very complex products have a place for certain segments of the population, but when we’re driving at first-time homebuyers, it’s very important we do it in a prudent, responsible manner. Offering them reliable, fixed payments for the foreseeable life of the loan, for the foreseeable ownership of that home, is very critical.”
The Mortgage of Millennials
The millennial generation is quickly becoming the largest segment of homebuyers, but their entrance into the market has been slow going. A more transient group with disparate income sources, a penchant for high-cost, urban areas and sky-high student loan debts have made homeownership difficult for today’s youth.
According to many lenders though, thinking outside the 30-year product box—as well as how those products are underwritten—could help bring more millennials to the table.
“I think millennials are different because the balance sheet looks different,” Salditch said. “They have these burdensome student loan debt payments they need to make. They tend to move into very competitive, expensive cities where rent has continued to go up and up. Oftentimes, this group is paying more than half of their income on rent, and that makes it really difficult to save for a down payment.”
Fercho, who previously worked at Fannie Mae, says adjustable-rate products are likely to grow in popularity as more millennials join the market.
“I think the millennials are more transient and less loyal to companies or geography,” Fercho said. “In some way, I think the advent of the internet has really enabled this large world to become really small. I think products that are going to be more in vogue for them would be shorter duration products. ARM products will be huge for the new millennial buyers, and I think that’s something that will definitely attract them more than a 30-year fixed-rate mortgage.
But ARMs aren’t the only option for millennial buyers on the home hunt. According to Tony Ebers, EVP of Originations at Mr. Cooper, equity-sharing products are also a viable tool for today’s younger generation.
“The concept of equity-sharing mortgages—where an investor shares in the appreciation in home value in exchange for down payment assistance or lower monthly payments—could enable more low- to moderate-income borrowers to become homeowners,” Ebers said. “Equity-sharing products could help millennials enter the housing market, providing some payment assistance for young buyers struggling with student loan and credit card debt.”
Still, most agree that it all comes down to underwriting. As millennials continue to earn income in new and innovative ways, lenders need to evolve and find ways to consider those income streams when evaluating a mortgage application.
“This group is paid differently, and that can be a real challenge for a traditional lender,” Salditch said. “Not only are we seeing more 1099s and less W-2s, but we’re also seeing them earn money from a side hustle. Being able to underwrite that kind of income is becoming very important for millennial borrowers.”
Underwriting Undergoes a Change
It seems better serving the millennial market is more than just offering non-30-year products. According to many lenders, it’s the entire underwriting process that needs to be reexamined. But Salditch, whose Better Mortgage specializes in serving millennial buyers, says doing so can be costly for traditional lenders.
“I think in general, it’s just more expensive,” Salditch said. “The underwriting process is just longer. Maybe they’re willing to do it, but they’re probably nickel-and-diming folks in order to do that.”
Still, many lenders are taking steps to adapt. Just take Fannie Mae’s latest move, for example.
“When I was at Fannie Mae, we had just rolled out a new student loan product which really looked at how you consider some of that debt and have it forgivable—or not included in a calculation of income—to be able to have the borrower qualify,” Fercho said. “I think we are going to have to look at more creative things like that to really have a significant impact.”
Salditch agrees that Fannie Mae—as well as Freddie Mac—are taking steps to revamp underwriting guidelines to meet the needs of up-and-coming buyers.
“I think that the GSEs, particularly Fannie Mae, are doing a lot with trying to modernize the underwriting guidelines,” Salditch said. “Lenders need to be able to work with them and bundle up opportunities to potentially serve a borrower that might have been shut out from traditional underwriting guidelines—provided they’re creditworthy.”
Salditch says it’s not just underwriting that needs a facelift though. When it comes to millennials, it’s the entire mortgage process.
“The way the mortgage process works does not necessarily favor this newer generation of homebuyers that might need a lower-down payment product,” Salditch said. “One of the things that we’ve done is we’ve launched something called the ‘Better Offer,’ which allows us to actually fully underwrite the borrower and the property before a purchase offer is even made. This allows borrowers to make a contingency-free offer, which we think helps millennials in particular—who are living in expensive cities, who need to stand out in very competitive markets—and particularly in markets that have a lot of cash buyers.”
In the end, it’s these innovative solutions—like those from Fannie Mae and Better Mortgage—that will pave the way for larger swaths of millennial buyers in the coming years. Developments in technology and big data will also benefit these buyers—particularly those who are self-employed.
“Technology has really enabled lenders to integrate automatic source data into their processes, and I think it’s something that is really changing the market and will be really useful to how we underwrite self-employed borrowers,” Fercho said. “I can easily see a day that, because of this access to information and it being verifiable instantly, where the concern over self-employed borrowers will really start to dissipate and it will be much easier to underwrite those borrowers. You’ll have the same confidence about their ability to repay that you would with a W-2 borrower.”
Serving Veterans and Other Minority Buyers
Millennials aren’t the only population segment that’s struggling to enter the market. According to Jones, a former Army captain, veterans are also having trouble getting the service—and products—they need to become homeowners.
The biggest factor? Jones says its misconceptions about VA loans which, most of the time, are the absolute best choice for a military buyer and their family.
“VA loans are a little bit more expensive for lenders to execute because of the specialized training on how to underwrite them,” Jones said. “They’ve got to pay these underwriters a little bit more. Because of that, they steer people away. Real estate agents misunderstand, too.”
Sometimes, vendors will even push veterans toward non-VA loans because of the added effort they take to process.
“Many loan officers will steer people away from using it and to an FHA loan product, typically, if it’s a first-time homebuyer,” Jones said. “On average, that’s going to cost the veteran $3,600 more in fees and interest over that 30-year period than they would have paid on a VA loan. It’s a real disservice. The lenders in the past have been complicit in that sense. They don’t understand how to execute VA loans properly.”
Changing legislation is one way to address the issue, Jones says, and he even suggests that veteran status be added to HMDA data, so lenders know automatically when an applicant is VA-eligible. Education for veterans themselves is also key, Jones says.
“Through education and through making people understand the VA’s actually looser guidelines—that it is actually easier for them to take out a VA loan—we can help make a difference,” Jones said. “It’s all about educating.”
Jones’ BBMC Mortgage partners with non-profit organizations to certify realtors, mortgage bankers and loan officers across the country on the VA loan process.
“Then they can go to market and say that they’re certified,” Jones said. “That’s making a dent. We’re doing our little part in that regard. I think that in general people understand that that needle needs to move, that we need to be more diligent in how we care for our veterans.”
But education isn’t just important for veteran buyers. Millennials crave it, too—and it could help bring more minority buyers to the table as well.
“We noticed a lot with this younger generation of homebuyers is this desire to really understand the transaction and talk to our loan consultants on the phone,” Salditch said. “They spend more time on the phone with us than other groups of borrowers. I think they really want some level of unbiased guidance.”
According to Fercho, offering education—and showing minority buyers that they do, in fact, have access to the market—is crucial.
“I think for minority homebuyers it still needs to be about education and ensuring that access,” Fercho said. “More needs to be done around education to get them to the table.”
Technology plays a big role in offering that education and ensuring all types of buyers—regardless of status or income—have a clear, understandable path toward homeownership. Both web and mobile tools are crucial for this, according to Ebers.
“One of the key ways to reach millennials is to offer easy-to-use online and mobile- friendly tools,” Ebers said. “Providing access to helpful information and comparisons on loan products, payments, and rent vs. own trade-offs, etc. in a simple, user-friendly manner is going to be critical in reaching these borrowers. Digital mortgages will allow lenders to better educate borrowers.”
Digitizing to Expand Access
eLending and digital mortgage tools can do more than just educate, though. According to some experts, it could even widen access to credit for millions of previously locked-out buyers.
“I think you will see access to credit open up to many more borrowers because it will really make it easier to get a mortgage,” Fercho said. “That digital technology really is the revolution that’s coming in mortgage. Then products and everything will just follow, and everything will be about the borrower’s choice and what meets their personal needs. The digitization of the whole process is what’s the game-changer.”
Schmitt says digital tools could even make refinancing more attractive, because of the more efficient process and, subsequently, lower costs for lenders to underwrite and approve a borrower. They could make the customer experience simpler as well, he says.
“I think it’ll take some of the frustration out of the customer experience,” Schmitt said. “From a consumer standpoint, it’ll simplify the documentation. There’ll be digitally verified sources, and it’ll be a much quicker experience. It will also probably be lower cost, which would have some impact on the cost to underwrite the loan.”
eNotes, in particular, are going to have a major impact, according to Fercho.
“The eNote is in its very early stages,” Fercho said. “Most states are adopting eNotary laws, and it should be no surprise to envision a future where you’re literally applying for and executing a mortgage from virtually anywhere. New buyers will be able to get that offer in on their dream home faster using those digital methods.”
The moral of the story? Fercho says it’s to hop on board and never look back.
“This very arduous, very complicated mortgage process is really getting a facelift, and it’s being re-imagined through digital technology and access,” Fercho said. “Lenders who continue to fight that digital movement by not continually analyzing their eLending offerings will get swallowed up by those bigger lenders who’ve embraced this new age in mortgage lending.”