Understanding Today's Mortgage Markets
Today’s mortgage market bears little resemblance to the market of just a decade ago. The widespread utilization of credit scoring and risk-based pricing, the development of a mortgage delivery system dominated by mortgage brokers, and the growing importance of secondary market activities has keyed a virtual revolution in U.S. financial markets. With new low downpayment products and a highly automated mortgage delivery system, the mortgage industry has dramatically expanded access to credit. This expansion in mortgage lending—especially in non-prime lending—has brought with it a diverse array of new mortgage products and channels. This growth has expanded access to credit to consumers who have not traditionally been well served by the mortgage market and has enabled millions of homeowners to tap accumulated home equity to help meet their consumption and investment needs.
Regulations have not evolved to keep pace with these changes. For example, uneven regulations across channels may make it more difficult for CRA-regulated lenders to compete with their independent mortgage bankers (IMBs), or non-bank, competitors. On the other hand, the regulatory structure governing the IMB channels may not provide higher risk customers with the same degree of consumer protection that they receive through a CRA-regulated channel. This lack of regulatory uniformity is both inherently unfair for the borrowers and can distort the marketplace, disadvantaging smaller CRA-regulated lenders.
Understanding Mortgage Channels
Each year, the U.S. residential mortgage market gathers trillions of dollars from investors around the world to meet the borrowing needs of millions of individual homebuyers and homeowners. In today’s complex mortgage delivery system, investment dollars flow through a variety of distinct mortgage channels as they make their way from investors to borrowers. These channels are defined by the hundreds of thousands of professionals engaged in the marketing and sales of mortgage products, the thousands of organizations and individuals that comprise the primary and secondary mortgage market, and the laws and regulations that monitor the activity of mortgage industry participants.
Historically, most residential mortgage funds flowed through deposit-taking institutions: thrifts and commercial banks. As recently as 1980, nearly half of all one-to-four home mortgages were originated by thrifts and another 22% by commercial banks. As access to non-depositary sources of residential mortgage capital has expanded, the growth of secondary market operations has fueled the rapid expansion of independent mortgage banking companies, as well as a host of mortgage banking subsidiaries and affiliates of traditional deposit-taking organizations. The rapid growth of these secondary market players has been matched by an equally dramatic consolidation of mortgage banking organizations. By 2005, the top 25 lenders accounted for close to 85% of the $3.1 trillion mortgage market.
The rise of subprime mortgage lending is linked to the rise of new mortgage delivery systems, including independent mortgage companies and their networks of mortgage brokers, as well as new mortgage conduits that securitize and sell mortgages on the secondary market. Recent papers by the Joint Center for Housing Studies (JCHS) seek to better understand the organization of U.S. capital markets, and the many distinct mortgage channels that link mortgage investors with mortgage borrowers (see web links at the bottom of the page).
Mortgage Channels Matter
These distinct channels have created a dual market system where funding for lower-priced mortgages flows through distinct channels linking investors to borrowers as opposed to alternative channels for higher-priced mortgages. For example, lower-priced mortgages typically flow from CRA-regulated institutions, either inside or outside their Assessment Area, to Government Sponsored Entities (GSEs). Assessment area definitions are based on the Federal Reserve Board branch location data. As a reasonable approximation to true Assessment Areas, these data assumes that if a lending entity subject to CRA has a branch office in a particular county, then that county is part of the entity’s Assessment Area. Loans made in counties where the lending entity does not have a branch office are assumed to be originated outside of the entity’s Assessment Area. Higher-priced mortgages tend to flow from independent mortgage bankers to the non-GSE secondary market such as private securitization.
Further, these mortgage channels differentially serve specific metropolitan areas, neighborhoods, and racial and ethnic subgroups. For example, across metro areas the share of mostly lower-priced Assessment Area loans varies. This most likely reflects the banking structure of these communities. For example, lower shares of Assessment Area loans may reflect an increase in larger outside Assessment Area lenders in the marketplace while smaller banks have withdrawn.
Figure 1. Assessment Area Loan Share Varies by Metro Area
Region definition: Alaska, Hawaii, Idaho, Montana, Oregon, Utah, Washington, and Wyoming
The HMDA database includes 20 Metropolitan Statistical Areas in the region: Bellingham, Billings, Boise, Bremerton, Casper, Cheyenne, Eugene-Springfield, Great Falls, Honolulu, Medford-Ashland, Olympia, Portland-Vancouver, Provo-Orem, Richalnd-Kennewick-Pasco, Salem, Salt Lake City, Seattle-Bellevue-Everett, Spokane, Tacoma, Yakima.
Source: Joint Center for Housing Studies enhanced HMDA database, using 2004 HMDA data
Similarly, metro shares of lower-priced and higher-priced loans vary significantly across the country. Some of this variation reflects the differences of borrower characteristics across these metro areas and the affordability challenges these different metro areas face. However, this variation may also reflect the different regulatory structures and regulatory legacies of the lenders in these metro areas.
Figure 2. Share of higher-priced/lower-priced loans by MSA
Most Lending Organizations Make Few Higher-Priced Loans
While the recent failing of a few subprime companies has raised questions about the oversight of subprime loans more generally, most lending organizations make few higher-priced loans. While some lending organizations offer a wide range of mortgage products, others tend to specialize. In 2004, 59.3% of lenders specialized in lower priced lending in the region and made 38.4% of all lower-priced prime loans, while these same organizations made just 1.8% of all higher-priced loans. This follows the national trends where 58.8% of all lenders (4,154 organizations) made 40.7 of all lower-priced prime loans (2.7 million), while these same organizations made just 2% of all higher-priced loans (27,000).
Figure 3. Organizations by Degree of Lending Specialization
|
Share of Organizations |
Share of
Lower-Priced Loans |
Share of
Higher-Priced Loans |
| |
Number |
% Dist. |
Number |
% Dist. |
Number |
% Dist. |
| Less than 3% Higher-Priced |
502 |
59.3% |
146,512 |
38.4% |
1,012 |
1.8% |
| 3-10% Higher-Priced |
118 |
13.9% |
126,756 |
33.2% |
9,742 |
17.4% |
| 10-20% Higher-Priced |
68 |
8.0% |
60,700 |
15.9% |
8,845 |
15.8% |
| 20-50% Higher-Priced |
78 |
9.2% |
29,053 |
7.6% |
13,955 |
25.0% |
| 50% or more Higher-Priced |
80 |
9.5% |
18,538 |
4.9% |
22,413 |
40.0% |
| All Organizations in the Region |
846 |
100.0% |
355,559 |
100.0% |
55,955 |
100.0% |
HMDA required lenders to disclose pricing information for first lien mortgages with an Annual Percentage Rate (APR) that is three percentage points above a typical prime loan for the first time. These loans are called “rate-spread” or “higher-priced” mortgages and are roughly equivalent to what industry sources call non-prime or subprime loans.
Region definition: Alaska, Hawaii, Idaho, Montana, Oregon, Utah, Washington, and Wyoming
Source: Joint Center for Housing Studies enhanced HMDA database, using 2004 HMDA data
At the other end of the spectrum a smaller number of lenders, just 9.5%, specialized in higher-priced lending, meaning that higher-priced loans accounted for more than 50% of their overall lending activity in 2004. These specialists made 40% of all higher-priced loans and 4.9% of lower-priced loans. This compares to the national statistics where 905 lenders specialized in higher-priced lending, meaning that higher-priced loans accounted for more than 50% of their overall lending activity in 2004. Of these, 17 large independent mortgage companies collectively originated 506,000 loans, or 39% of all higher-priced loans originated that year.
In other words, most local players do not make higher-priced loans, while a few larger higher-priced specialists make most of these loans. In between these two extremes, many organizations provide a mix of both higher-priced and lower-priced mortgages. Collectively, the non-specialist organizations originated over half of both higher-priced and lower-priced mortgages.
Withdrawal of Small Institutions from Mortgage Lending
Lacking the economies of scale to compete with the financial services giants, many smaller banks and thrifts have scaled backed or entirely abandoned their mortgage origination, choosing instead to refer customers to other mortgage lenders. The growth of the independent mortgage bankers, or non-banks, is apparent in both the higher-priced and lower-priced marketplace. This is illustrated by the strength of non-banks as both higher-priced and lower-priced specialists.
Where 50% of all loans are higher-priced the lender is a defined a ‘higher-priced specialist’, and where less than 3% of all loans are higher-priced the lender is a ‘lower-priced specialist.’ Of these specialists in the region, just 1.3% of all loans made by higher-priced specialists are made by CRA-regulated lenders within their Assessment Areas (and 12.9% outside their Assessment Areas), whereas 84.9% of all loans are made by higher-priced specialists are made by independent mortgage bankers. Meanwhile, 23.3% of all loans made by lower-priced specialists are CRA-regulated lenders within their Assessment Areas (31.1% outside their Assessment Areas), while 33.2% of all loans made by lower-priced specialists are independent mortgage bankers in the region.
Lack of Uniformity of Regulations is Inherently Unfair
The various components of this complex mortgage delivery system are governed by an equally complex set of laws and regulations, as well as the self- regulation efforts of a range of mortgage industry organizations. Unfortunately, this complex regulatory structure has not adapted to the substantial changes in the mortgage industry that have occurred over the past quarter century, including the dramatic increase in subprime lending and the emergence of new organizations that specialize in subprime lending. The result is that many basic consumer protections commonly available in the prime segment of the market are absent or less diligently enforced in the subprime segment.
As ever decreasing shares of mortgages are originated by Assessment Area Lenders, increasing numbers of loans have limited oversight. As non-bank lenders, independent mortgage bankers are less closely monitored by the Community Reinvestment Act and other federal-level regulations that focus on banks and thrifts and their subsidiaries and affiliates. Under the existing federal regulatory framework, higher-priced loans flow through mortgage channels that are subject to the least extensive regulatory scrutiny. This lack of uniformity of regulations is inherently unfair. Mortgages made in individual metropolitan areas, neighborhoods are subject to differing degrees of regulatory oversight. As a result, the most vulnerable borrowers are less likely to benefit from federally mandated consumer protections that are more widely present in the lower-priced prime market. This lack of uniformity can also distort the market. Solutions to existing industry problems—whether they be regulatory or market driven—must be applied in a uniform manner to all mortgage market segments. Absent that, some will continue to use questionable practices to gain competitive advantage.
Meeting Customers Demand
To meet their customers demand, it is important for CRA-regulated lenders to understand these trends. Many CRA-regulated lenders are reluctant to offer subprime loans either because of its specialization or because of the associated reputational risks. Beyond adding new subprime products to their services, lenders still have an opportunity to meet the credit needs of the community by referring their customers to reputable players in this higher-priced lending space.
Ren S. Essene, MPA, is a Senior Research Analyst at the Joint Center for Housing Studies at Harvard University and serves on the Federal Home Loan Bank of Seattle Affordable Housing Advisory Council.
About the Studies
Harvard University’s Joint Center for Housing Studies is the nation’s leading center for information and research on housing in the United States. Established in 1959, the Joint Center is a collaborative unit affiliated with the Harvard Design School and the Kennedy School of Government. The two reports MM07-1: Understanding Mortgage Market Behavior: Creating Good Mortgage Options for all Americans by Ren Essene and William Apgar and MM07-2: Mortgage Market Channels and Fair Lending: An Analysis of HMDA Data by William Apgar, Amal Bendimerad and Ren Essene, along with additional information about the Center and its programs and activities are available at www.jchs.harvard.edu.
For copies of the complete studies, please go to: www.jchs.harvard.edu/understanding_mortgage_markets.