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Lenders Preferred Refinancing Over New Purchases Post-Crisis

After the Federal Reserve began quantitative easing (QE) in late 2008, lenders largely began favoring refinancing applicants over new purchase ones, according to a new study by economists and financial experts Dong Beom Choi, Hyun-Soo Choi, and Jung-Eun Kim

The study found that many banks, particularly those with limited risk-taking capacity, were more likely to approve refinancing applications than they were new purchase ones after the financial crisis.

“While this difference might merely reflect relatively weaker demand for new purchase mortgages,” Choi, Choi, and Kim stated in a blog post, “the approval rate for refinancing applications also rebounded much more sharply after the crisis. These results suggest that lenders were more likely to approve and originate refinancing loans than new purchase loans after the crisis and during the QE period (after the fourth quarter of 2008). “

Published on the Federal Reserve Bank of New York’s Liberty Street Economics blog, the post suggested that in a post-crisis world, refinancing applicants were easier to evaluate—from a risk standpoint—than new originations were.

“In principle, if QE reduces mortgage rates, it should increase demand of both refinancing and new purchases,” the post stated. “However, for banks with limited risk-taking capacities as a result of the crisis and recession, the two types of loans might not be equal—the banks can easily observe the payment history of the refinancing applicants, but such information might not be available for the new purchase applicants, such as first-time buyers.”

Federal refinancing assistance programs, like HARP, also helped to subsidize these applicants, giving lenders even more impetus to approve them over those in other segments.

“Given the capacity constraint,” the post stated, “a bank might have preferred applicants for refinancing over those seeking to finance new purchases.”

The biggest culprits were “weaker” banks—those with less capital and more non-performing loans.

“Faced with the QE-driven mortgage applications, weakened banks with low capital and high nonperforming loans might have been more comfortable with refinancing existing mortgages than with taking on ‘new’ risk.”

Ultimately, the post suggested, this leaning toward refinance applicants likely impacted the overall efficacy of the Fed’s QE efforts.

“Our results suggest that while QE did stimulate mortgage lending, banks with limited risk-taking capacity as a result of their weakened balance sheets seemed to favor refinancing existing mortgages over originating new ones. This friction may have limited the impact of QE on new originations (and the spending associated with it) and may also have created distributional effects between existing and would-be homeowners.”

Read the full results of the study at LibertyStreetEconomics.NewYorkFed.org.

About Author: Aly J. Yale

Aly J. Yale is a freelance writer and editor based in Fort Worth, Texas. She has worked for various newspapers, magazines, and publications across the nation, including The Dallas Morning News and Addison Magazine. She has also worked with both the Five Star Institute and REO Red Book, as well as various other mortgage industry clients on content strategy, blogging, marketing, and more.
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