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ComplianceFinanceAugust 29, 2023

Competition is growing and margins are tight

By: Matthew Mackey

Credit unions are well positioned to benefit from home equity lending

(As published in the ACUMA Pipeline, Summer 2023)

When it comes to residential lending, home equity loans have been one of the few bright spots over the past year. Home equity lenders, including many credit unions, originated more than 2.7 million home equity lines of credit (HELOCs) and loans in 2022, according to TransUnion, and that number is expected to grow by nearly 25% and top 3.7 million units this year. Several powerful trends fuel the shift to home equity lending. The first, of course, is the Federal Reserve’s campaign to combat inflation. Since mid-2022, the central bank has raised interest rates 10 times, including May’s 25-basis-point hike. This, in turn, has pushed first mortgage interest rates from a record low of 2.65% to as high as 7% in recent months and choked off cash-out refinances that had been the transaction of choice for much of the last decade.

The second driver is home price appreciation. Over the past two and a half years, Home Price Index (HPI) gains have created trillions of dollars in tappable home equity for U.S. homeowners. Even though HPI growth has slowed recently, TransUnion is forecasting that by year end tappable home equity will still total $18.1 trillion.

The “locked-in” effect is also a factor. More than 85% of all outstanding first mortgages currently have coupons of 6% or less, including millions with rates as low as 2% to 3%. As you’d expect, homeowners are reluctant to refinance their historically low first mortgage interest rates. But they still want the ability to access their equity which is why, for the foreseeable future, HELOCs and HELs (home equity loans) will be the products of choice when consumers need money for big-ticket items like home renovation, college tuition, debt consolidation, and others.

Home equity interest rates in the high single digits or even low double digits are still very attractive when compared to rates for non-mortgage debt, like credit cards. “Currently homeowners have over $600 billion in non-mortgage debt, and this is anticipated to increase in 2023 as inflation takes its toll on consumer wallets,” TransUnion noted in a recent report. “Homeowners can considerably reduce their monthly expenses by tapping their home equity to pay off existing debt.”

The credit union advantage

During the refi boom, many credit unions lost ground to mortgage banks. Credit unions often found themselves facing off against large national lenders with mega advertising budgets — it’s hard to compete against a splashy Super Bowl ad. Now that the market has shifted to home equity, credit unions are leveraging one of their key advantages — their relationship with members — and aggressively marketing their ability to meet members’ financial needs via home equity lending.

The dynamics of home equity lending also give credit unions the upper hand. Unlike first mortgage loans that are often sold into the secondary market, HELOCs are portfolio loans and are usually held on balance sheets, which disadvantages mortgage banks.

Also, HELOCs are a core product for credit unions who know how to handle drawing and servicing HELOCs.

Lower cost but also lower margins

For the most part, home equity lending tends to be less complicated and less expensive than first mortgage origination. But there are settlement services costs, including, in some cases, full appraisals and title, and labor costs for underwriting and processing. Unlike first mortgages, many of these closing costs historically haven’t been passed along to the borrower. When you consider the smaller size of home equity lines and loans, the borrower’s ability to control the draws and need to absorb costs, home equity margins tend to be lower.

So, to be successful at home equity, credit unions need to focus on origination costs and use as much automation as possible to protect their margins.

From a risk standpoint, credit unions need to be concerned about credit, how they value equity, and their position on the title. In the event a second lien goes bad, there is very little chance of recovery. Having said that, home equity products tend to perform very well compared to other types of consumer credit.

Another factor is that compliance is less rigid within home equity lending. For example, there aren’t standard forms for HELOCs like there are for first mortgages. It’s basically up to each lender what forms they use and how they ensure that internal rules are being followed.

Competition is increasing

While credit unions have a home-field advantage when it comes to home equity, large national lenders and new fintech entrants are also focusing on this sector and stepping up their marketing to emphasize speed and the customer experience. In some cases, they are offering HELOC approvals in minutes and closings in a matter of days. To compete going forward, credit unions will need to offer fast decisions, convenient closings, digital document presentation and eSigning.

Cost and efficiency are also considerations. Does it make sense, for example, to originate first mortgages on one platform and with one set of document providers, but use older core banking systems, or even a paper process, for HELOCs? Wouldn’t opting for a single, residential lending platform and single set of document providers offer greater efficiency and better visibility across different types of assets? There are even new solutions that allow lenders to create digital HELOC assets, similar to first mortgage eNotes.

Selecting the right partner

As credit unions rethink their approach to home equity, many are also re-evaluating their current roster of technology, document and compliance partners. Some are looking at enhancing just a single function, like document generation, while others are taking a more holistic approach and looking for providers that can deliver a range of solutions that can be delivered under existing agreements.

Like our company, Wolters Kluwer, many firms have a long history of supporting the credit union community with solutions ranging from document generation to eSignature and eClosings, lien analysis and digital HELOC originator and eVault storage.

At the end of the day, good partner firms understand that membership service and support are essential to the mission of the credit union community. They also know that many credit unions can’t afford the investment in technology and resources that larger mortgage companies have made, and have designed systems to be flexible, customizable and affordable.

Credit unions would be well served to leverage their unique advantages — an existing and loyal customer base, and a captive prospecting pool — with the efficiencies of technology to capitalize on the significant opportunity that exists with home equity lending.

Matthew Mackey
Sales Channel & Affiliates Associate Du
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