I don't know exactly when and how fast refinances are going to go away. I only know they will, and pretty much everybody I've talked to agrees. Some say refinances won’t dry up that fast, but nobody is saying, “Nope, rates are going to drop some more.”
As far as predictions go, Fannie Mae thinks the percentage of purchases will be about 58% in the fourth quarter of 2021 and the MBA says 72% will be purchase business. Whether it’s the third or fourth quarter of 2021 or perhaps the first quarter of 2022, it doesn't change the fact that lenders need to be planning for a purchase market.
Fortunately, history has taught us a few things about purchase markets that we can use to our benefit as we roll into this one.
Higher Costs in a Declining and More Competitive Market
It’s a fact: people who are able to source purchase loans often require higher compensation because they spent years developing relationships with real estate agents and others who provide them with referrals. Because independent mortgage bankers (IMBs) tend to do more purchase loans, they devote years to developing a salesforce focused on real estate agents and homebuyers. When recruiting in a purchase market, I don’t want originators who have only feasted on refinances. Purchase loans are more complicated transactions, so I need loan officers who have relationships that bring in referrals—and I’m willing to pay more to get them.
In a purchase climate, we’re also more likely to see multiple loan officers fighting over the same deal. Just like today’s real estate market, where multiple buyers fight for each home because there is not enough inventory, in a purchase market, loan officers will fight for each loan, so they are more likely to compete on price to get the deal. Sales costs will go up (in order to get the good LOs) and revenue will go down because you have to fight on price a little more.
The Pattern to the Refi/Purchase Cycle Hasn’t Changed
In the last 10 years, there has not been a single year in which refinances have not gone up or down by at least 20%. In fact, in 2019 and 2020, the number of refis rose 100% each year. That’s a staggering number. Every single year, we end up having a huge, mostly unpredicted whiplash in refinance transaction volumes. On the other hand, purchase loans have merely bumped along. For a decade, we have not had a year where purchase loan volume went up or down by more than 15%, and a 15% purchase increase only happened once. Most years, purchase volume fluctuations are 10% or less.
So, we know it's going to be painful in the next year because we're going to see a big drop in refinance volume. But we're probably going to have a good purchase market, and purchase volume is going to be within a predictable range. Good lenders will at least be able to build a plan to grow purchase volume in their marketplace, and transactions are likely going to be pretty darn close to what they expect.
I know some reading this article will say, “Not in my market. We're getting hammered on inventory and we're not sure where our next purchase is going to come from.” That might be true. Certain pockets may continue to see everybody bidding on multiple properties, which will make it hard to get the deal, or inventory may remain low. Perhaps the first-time homebuyer market will collapse due to rising prices. In some local markets, there could be some macro impact, but it isn’t going to be 100% a year, year-over-year.
Staff Will Be Significantly Less Productive
Think about it: with a refinance, the borrower usually talks to one loan officer, and maybe checks out rates online. That loan officer asks a couple questions, tells the borrower what the new, lower monthly payment will be, and asks, “Do you want to refinance your loan?” If the answer is yes, the process is not much more complicated than that. As long as the loan officer can get the loan to the borrower at the quoted terms and closes quickly enough, the borrower will close. The toughest thing last year was that there were so many of these opportunities, it was hard to juggle them. However, they were all pretty much like this.
Purchase loans are tougher to do. A purchase loan goes like this:
Borrower: “I’m interested in buying a home.”
LO: “Great! Where are you in the process?”
The borrower may not yet have a house in mind, may not have sold their current home, may or may not want to use the proceeds from their current home as a down payment, may not have a real estate agent, and may not have even decided on the neighborhood or price range.
Regardless of where the borrower is in the process, however, the lender has to be there. It’s episodic. Rarely can you close a purchase deal on a first call because there is either an influencer who needs to be sold, or there are a host of things the lender can’t control that have to be accomplished before the loan officer can sell the mortgage.
In a purchase market, instead of having 50 to 100 simple refinance opportunities every month (two to three per day), a good loan officer may only get 25 to 30 purchase opportunities in a month (more like one new opportunity each month). Also, each of these opportunities is much harder to manage. The good LO will also be juggling these opportunities for six months, because that’s how long it often takes for a borrower to work their way through the sales cycle and become a buyer. A great loan officer might convert 10 of these opportunities, and that’s if they are a top producer. Because loan officers can’t handle as many purchases as refinances, they’ll need to be paid more because they are probably the one who sourced the referral in the first place.
The complexity of the purchase loan drives the process. Think of it in project management terms. In project management, projects are ruled by three constraints, often called the “Iron Triangle”—time, features (or scope), and resources (or costs). If any of these elements are fixed, the others must be flexible.
On a purchase loan, time is fixed, so a lender’s resources must be flexible. Lenders must staff every single function in operations for peak on-time delivery. On refinances, the lender can spread the transactions out across the month and balance staff accordingly. Not so on a purchase loan. Like a project that has a set end date, all activity must be planned against that date and finished by the due date. Underwriters, processors, closers—all have to finish on time.
Barriers Come With Opportunity
While the purchase market will be harder, there are still opportunities to excel. Even while they feasted on refis, the best mortgage lenders continued to build the skills, products, and people they need to effectively compete on purchase loans. They know that purchase is the market we're always headed toward at some point, and they are well positioned to manage through it.
If there’s any lesson to be learned here, it’s that you have to constantly be thinking about and planning for the next stage in the market—because it’s not a matter of if the market will change, but when.