This piece originally appeared in the April 2022 edition of MReport magazine, online now.
The moment housing economists have foretold is finally upon us: the end of the refi boom. For the past two years, mortgage rates have remained at historic lows, creating a frenzy of homeowners rushing to refinance. But in the first few months of 2022, mortgage rates have risen sharply in anticipation of the Federal Reserve’s strategy to stabilize inflation. On March 16, 2022, the Federal Reserve announced its first rate increase of 25 basis points. In that same week, the Mortgage Bankers Association (MBA) reported the 30-year fixed rate rose to 4.5%—more than a full percentage point increase in comparison to one year ago. As a result, we are seeing a significant drop-off in refinance activity. As of March 18, 2022, the MBA Refinance Index dropped nearly 55% compared to a year ago.
As the mortgage landscape transitions to a purchase market, lenders need to be prepared to change their approach to fit their borrowers’ needs. Today’s purchase borrowers are faced with a series of challenges navigating one of the most difficult housing markets in recent memory. Consider a current homebuyer’s experience: home prices are at the highest levels ever recorded, there is limited inventory to choose from, and competition often leads to bidding wars and price escalations. With home prices continuing to climb higher and mortgage rates increasing, the dream of homeownership is being pushed further away for many buyers. According to the Radian Home Price Index, provided by Radian subsidiary Red Bell Real Estate LLC, home price appreciation set a new record in 2021, rising 14.2% year over year. And in the last quarter of 2021, it rose 17%.
Affordability has become a major obstacle for many homebuyers but especially for first-time homebuyers who haven’t been able to benefit from home price appreciation. Coming up with a substantial downpayment is out of reach for many. With the median price of a home in the United States now above $300,000, that means first-time homebuyers need to have more than $60,000 cash in their pockets to make a 20% downpayment.
Homebuyers are stressed—exhausted by the process and strained financially by the increasing costs. While lenders may be powerless to solve the housing shortage issue, they do have a tool at their disposal that may make all the difference for borrowers. Thank goodness for mortgage insurance (MI), which can be the key to helping more buyers afford a home in this environment.
Thinking of mortgage insurance as an advantage requires a shift in perspective for many lenders and borrowers who are used to viewing mortgage insurance as a “necessary evil.” Many see it simply as an additional cost to the borrower. However, MI calls for a fresher look, as it has a range of benefits for borrowers that lenders should consider carefully, especially in this rapidly appreciating real estate market.
1. Allow the Borrower to Buy Sooner
Waiting to save a 20% downpayment can be a huge barrier for many first-time homebuyers. And, as home prices continue to rise, the savings needed also increase. With private MI, a borrower may be able to purchase a home with as little as 3% down. Rather than needing $60,000, as with the previous example, they may be able to purchase a home with a downpayment as low as $9,000. Buying a home earlier means that the homeowner can begin to build equity and long-term wealth rather than waiting to enter the market.
2. Cover an Appraisal Gap
In today’s highly competitive market, many potential buyers are offering well above the asking price and waiving traditional contingencies such as appraisal. While these strategies can help a buyer secure their dream home, they also can become very expensive when the appraisal value comes back less than the buyer’s purchase price. Mortgage insurance can be a simple and nearly seamless solution that may also work for buyers facing an appraisal gap. In certain instances, MI may be used to shift the loan-to-value ratio (LTV) and restructure the loan so borrowers can cover appraisal gaps and still have enough money to meet minimum down payment requirements.
3. Preserve the Borrower’s Savings
Even for borrowers who could afford a 20% downpayment, they may still seek a lower downpayment with MI as an opportunity to set aside some cash as a cushion for uncertain economic times. Also, as interest rates increase, so do investment yields on capital. That means a buyer may be able to earn a better return on invested cash now than in recent years when interest rates were lower. This could help offset the cost of MI.
4. Alternative to Buying Down the Mortgage Rate
If a borrower is concerned about rising rates and the impact they will have on monthly payments, MI may offer a solution. A rate-conscious borrower might pay extra buydown points at closing to reduce their interest rate. But by buying split premium mortgage insurance with a lump sum up front, that borrower can lower the payment on their MI which in some cases may save them more each month than buying down their note rate on the mortgage.
5. Cancel MI Early With an Appraisal
Keep in mind that most MI products are temporary. Once the borrower makes a certain number of payments, or the property appreciates to a certain value, the insurance may be canceled. When home prices go up rapidly, as they have in recent years, the payment can drop away even faster. For example, in a market where home prices are increasing by 10% to 15% each year, a borrower with a strong appraisal could qualify to cancel MI after two or three years with approval from the servicer.
It is time to change the narrative on MI and view it not as a burden but as a benefit for those who need it. MI has helped more than two million families become homeowners in the last year alone. As the mortgage market shifts rapidly from refinance to purchase, lenders are repositioning their focus on how best to structure transactions in this environment. Savvy loan officers will find creative ways to help their borrowers navigate the challenging market. For them, MI may be another means of bridging the affordability gap for homebuyers and unlocking hidden value for borrowers in an increasingly competitive market.