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The Cost of Quality

This piece originally appeared in the May 2022 edition of MReport magazine, online now.

During the pandemic months, as interest rates dropped to record lows, the mortgage industry cashed in. The housing market boomed, and originators benefitted from a surge in demand from new homebuyers as well as a rush to refinance from homeowners wanting to lock in historically low rates. However, the housing market is moving into a new season, and its “winter months” are coming.

While all focus is on the Federal Reserve’s interest rate moves after its latest rate hike in March, one of the greatest impacts to mortgage rates is the Fed’s drawback from the mortgage securities market. As the central bank provides less liquidity to the market, mortgage rates have quickly risen. Whether or not the Fed will continue this trend or reverse course to try to slow inflation will remain a guessing game for the remainder of the year.

Heading into 2022, mortgage rates hovered near the 3% mark, according to data from Freddie Mac. However, as the first quarter drew to a close, rates were well above 4%, with some economists even beginning to question when they may breach the 5% mark. As rates rise, the demand from homebuyers and homeowners will continue to fall, leaving mortgage lenders to compete for the borrowers that remain, for top talent, and to find a way to build a more elastic infrastructure. The right technology and attention to quality will determine who comes out on top in that competition.

Is the Housing Market Headed for Disaster?
Interest rates are rising, hovering near the 4.5% mark at the end of the first quarter of 2022, according to Freddie Mac data. Some economists predict rates could rise as high as 5% by the end of the year. This is putting significant strain on the housing market when it comes to affordability, especially as home prices also continue rising.

Home prices consistently rose near 20% year over year in the final months of 2021, and while this increase has slowed, the gains remain significant, according to the Home Price Index from CoreLogic. In fact, it predicts that by December 2022, home price gains could slow to just 3.5% annually. However, the COVID-19 pandemic presented unprecedented challenges, and not all economists agree on how much home prices will slow in the year ahead. For example, Ed Pinto, American Enterprise Institute’s (AEI) Housing Center director, predicts the boom will continue, and home prices will decrease to 10% gains in 2022, staying in the double digits.

As both home prices and interest rates rise, it could price many potential homebuyers out of the housing market.

Inflation is also running at a 40- year high, according to the latest Consumer Price Index (CPI) data from the Bureau of Labor Statistics (BLS). This could also slow economic growth and make it harder for consumers to save for any sort of down payment to buy a new home. While the economy does not appear ready to crash like the housing crisis in 2008, mortgage lenders should certainly prepare for a significant drop in demand for originations in the year ahead.

As mortgage demand drops, a focus on quality will become critical for mortgage lenders’ longevity. In fact, using technology to

improve quality could even help lenders improve margins as they scale to the new level of demand. The key challenge is how to deliver quality with increasing cost. Technology can deliver a cost-effective solution for more lenders to deliver better process outcomes.

Today’s market is seeing increased volatility due to inflation in the United States, geopolitical conflicts, emerging COVID-19 variants, and much more. When the market shows volatility, it is important for lenders to be ready for every direction it could take. Technology that produces high-quality mortgages will help them do that without the cost of adding new staff in today’s difficult labor market or worrying about how to retain staff as demand drops back down.

AI Solutions Deliver Both Quality and Cost Savings
Many lenders may be hesitant to focus on quality because of the staff levels required to attain desired levels during the manufacturing process. Heading into a down market some may make the difficult choice to contain volume rather than risk a high payroll. However, a constructive outlook reveals that Autonomous Intelligence solutions such as Candor Technology’s Loan Engineering System, combined with task automation and document indexing products, could cut a lender’s costs while also managing quality control.

This year, Freddie Mac has increased its focus on quality control (QC). In fact, it recently released a memo informing lenders that it is time to double down on QC best practices. It tells lenders to perform checks such as monitoring their performance carefully and performing regular checks on third parties, revisiting QC practices, incorporating controls and reviews that promote fair lending principals, and more.

This comes as Freddie Mac said it discovered an increase in critical defect rates in 2019 and 2020 as lenders struggled to meet the rising demand for originations. It acknowledged much of the increase in defect rates could have been related to changes in incomes, temporary unemployment, and other factors that made it difficult to evaluate income stability.

“Loan quality defect rates increased among some lenders during 2020, underscoring the need for a more reliable QC process amid increasing mortgage volumes, changing agency requirements, and remote work,” Freddie Mac said in its memo. “The goal: To avoid costly repurchases

and defaults as well as lessen the threat to communities from foreclosure.”

The GSE said that lenders must learn to navigate the balance of meeting demand without sacrificing quality. In the year ahead, QC will remain critical as lenders continue to assess borrowers’ financial situations that will be different due to the pandemic and deal with potential fallout from QC errors they missed in the past year when demand was high.

To ensure lenders are performing at their best state, technology will become critical to success as the GSEs turn their eye to quality control.

From Vicious to Virtuous: Reinventing the Cycle
As lenders look to get to borrower surety more quickly, and reduce costly cycle time, this has traditionally meant hiring more people to work throughout the process. However, this grows costly and can increase the likelihood for error, particularly when more layers of people are added to QC of other’s work. When searching for quality, the only way to achieve it is to remove the sluggishness, subjectivity, and inconsistencies associated with stacking people in the process.

Ideally, lenders can incorporate a layer of AI that can make the complex, intuitive decisions that require expertise and sound judgement with no human assist. Using such a technology platform, underwriters can improve productivity, concentrate on difficult scenarios, and know the quality of every loan is exceptional.

Using technology also cuts back on origination cycle times. Lenders who leverage technology that automates the assessment of borrower assets and income are seeing a three- to five-day reduction in their loan origination cycle times while also reducing risk, according to Freddie Mac.

But who’s guarding the guards?

If we learned anything from the 2008 meltdown, it’s that we lacked a robust loan-level audit trail. While the income used to qualify could be identified, the metadata and information was not aggregated, without which it’s impossible to understand the entire history of the underwrite or justification for the lending decisions made.

Get Busy Growing, or Get Busy Dying
Adapting AI into the lending cycle also helps cut down on loan cycle time by allowing lenders to get a full conditional approval at POS. This offers value in two ways: it makes your LO much more competitive and it reduces fallout. Additionally, conditional approval at POS strengthens your borrower relative to cash buyers—a very attractive distinction to have in the current competitive market. Retaining top LOs requires you make them as competitive as possible.

Another layer of value that technology will add is addressing the growing talent gap in the industry as veteran players retire. Increasingly we’ll see teams struggle to replace talent retiring. A recent report from the employment site, Zippia found that the average age of Loan Officers is 40+ years old, which represents 64% of the population. Here’s the challenge this dynamic creates. On the one hand, finding talent is hard. We are seeing this phenomenon play out across industries.

On the other hand, getting new employees up to speed with what an industry veteran knows and does is a challenge. Naturally, it’s likely that, as loan officers age out, they will look to sell their business. Tech shouldn’t require all new onboarding; instead, it should be a seamless transition in the event of M&A.

Technology can be what keeps lenders profitable even as demand dies down, or enable them to scale up and handle more originations as demand rises. Unlike new staff that needs to be trained and checked, tech can help ensure QC by using data in its decision-making and leaving a traceable trail of its decisions.

As regulators and even the GSEs become increasingly attentive to errors, and loan repurchases rise, having a strong technology partner can help make or break a lender’s future in the mortgage industry. Freddie Mac announced that now is the time to focus on QC, which can only be done by removing human error from the equation—or by removing humans altogether. Underwriters can use technology to perform the quick, simple tasks that slow them down, enabling them to easily scale their workflow to meet the market demand without sacrificing quality.

With Freddie Mac predicting demand could remain high, and emphasizing that a focus on QC is critical, lenders should examine their current processes and technology. If a focus on QC is lacking coming off last year’s boom in originations, now is the time to invest in the right technology that could keep your business from crashing.

The bottom line is that lenders must embrace technology as a way to deliver constant quality on a cost-effective basis. Lenders shouldn’t react to the next housing market disaster to pivot; it’s crucial to make quality in your operations shine today. With the right tech, lenders can be assured that, regardless of which direction the market takes—up, down, sideways—loan quality remains constant.

About Author: Sara Knochel

Sara Knochel is the CEO, Data & Analytics, for Candor Technology.
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