While a recession is a mere technicality, inflation and other adverse economic factors are already working to make the risks in the mortgage industry that have accumulated over a 13-year expansion more likely to become reality. How nearly $12 trillion in outstanding mortgage debt will perform during an extended downturn remains to be seen. Mortgages already show worrisome signs posting their biggest monthly drop since 2009.[1] The question is, “what happens next?”

Mortgage lending is as old as time. Among glittery new financial products, technologies, and services, mortgage lending seems as traditional as it comes. Still, nearly everything has changed over the span of just 14 years. Who holds the debt? How well was risk considered when the debt was originated? Who provides the liquidity, and what are the sources? How much is the asset really worth? How do you know? What is the cost of servicing the debt? How resilient are debt servicers? How willing and able will borrowers be to pay their debts? How flexible are creditors to assist borrowers and to restructure bad debt? How do creditors account for potential and realized losses in their portfolios? What tools do regulators and policy makers have to assess risk and intercede if necessary?

Answers to these questions have changed since 2008, and all those changes have occurred during relatively benign economic and credit conditions, the COVID dip notwithstanding. The regulatory and policy response to COVID provided some insight into the actions regulators and policymakers may take to avert the most severe impact of a mortgage meltdown. Still, predicting the cumulative effect of those changes during a more adverse and longer period is akin to predicting the performance of O-rings during a cold snap.[2] In such a complicated system, risk can be obscured by the obvious.

This article discusses some of the most significant changes to the mortgage industry since 2008 and suggests where industry participants, regulators, and policymakers should focus their efforts during the coming months to mitigate the risks baked into the housing market and economy. The article generally focuses on national trends affecting single-family mortgages and does not consider rental properties or second liens (home equity loans), which also affect housing markets. The article is not intended to inform specific investment decisions, rather it is intended to provide stakeholders a broader perspective of influences in the marketplace today.

Mortgage Origination and Servicing Has Migrated Out of Commercial Banks

When the Office of the Comptroller of the Currency (OCC)[3] and later the Office of Thrift Supervision (OTS) began publishing the Mortgage Metrics Report[4] in 2008,[5] no other source existed that documented the performance of the nation’s mortgage portfolio and the efforts to manage the growing number of delinquencies and resulting foreclosures. Loan modifications were used by exception prior to that point and never at scale. Creating a report that would become required reading for the likes of Alan Greenspan meant asserting authority to require institutions to report mortgage data in standardized forms for the first time and on a regular basis going forward. Establishing that process involved the arduous and contested task of creating industry-wide definitions for what are accepted terms today and would influence successor federal and private sector reporting for the following decade.[6] Since then, more representative and comprehensive data sources and reporting have become commercially available.

While difficult, the OCC and OTS then had the distinct advantage of supervising the institutions that serviced most outstanding mortgages in the country. At the time, just 14 large banks and savings associations serviced more than 60 percent of all mortgages in the United States—roughly 35 million first-lien mortgages worth $6.1 trillion.[7] About 88 percent of those mortgages were serviced for third parties. This provided a clear window into the performance of a large portion of the market.

Despite its size, the OCC and OTS supervised loans were not representative of the broader market, and the report incorrectly became a proxy for the entire industry for more than a decade. This portfolio provided a rosier picture than the whole because the riskiest origination practices and the worst loans occurred outside the commercial banking system as then Comptroller of the Currency John Dugan explained to the Financial Crisis Inquiry Commission.[8]

Still, this concentration gave policy makers a target for focusing their relief efforts and safeguards following the 2008 crisis. It also provided greater clarity and insight for bank regulators regarding mortgage-related risk within commercial banks and allowed them to work aggressively to address troubled assets and the condition of those banks as well as focus on relief to the millions of those banks’ customers. Operational failures during that period resulted in tens of billions of dollars in fines and remediation and required nearly a decade to satisfy enforcement and supervisory expectations, costing billions more.

Today, commercial banks still play a large, but less central, role in the mortgage industry. The majority of origination and servicing occurs outside commercial banks. The latest OCC report, for instance, covers just 22 percent of all residential mortgage debt outstanding in the United States compared with more than 60 percent in 2008.[9]

The robust private-label mortgage-backed securities market that existed prior to 2008, also is gone. Only the government-sponsored enterprises, Freddie and Fannie, and Ginnie Mae (which securitizes government-guaranteed mortgages from the Federal Housing Administration (FHA), Department of Veterans Affairs (VA) and Department of Agriculture) securitize loans in significant numbers.[10] The GSEs primarily attract the highest quality, least-risky loans within their allowable loan size limits, while Ginnie Mae primarily serves minority and first-time homebuyers. As the primary securitizers and providers of liquidity, these actors also have tremendous power to set market standards for quality and underwriting, along with rules on qualified residential mortgages from regulators. On the margin, there has been some revival for private-label mortgage-backed securitizers fueled by the hot housing market of recent years with analysts predicting $132 billion in private-label securities to be issued by the end 2022, including $78 billion in prime, $34 billion in nonprime and $21 billion in government-sponsored enterprise credit risk transfer deals.[11]

More and more the mortgages in these securities are originated outside commercial banks and even outside the traditional nonbank lending community. The share of mortgages originated by online mortgage companies or financial technology (fintech) firms has quadrupled since 2016 reaching 66 percent of the market.[12] Fintechs have won market share for obvious reasons—better customer service, quicker closings, and greater convenience as the cumulative effect of regulatory burden made mortgage origination and servicing less profitable for many depository institutions. They have also earned share by expanding the market and potentially identifying additional creditworthy borrowers ignored by traditional lenders, through use of alternative data and models.[13]

Ironically though, the very advantages that gained fintech market share in the first place may have unintended effects that regulators and policymakers will watch closely. The features of fintech products and their transmission via social media help them act as an accelerant of monetary policy and market shocks, according to Federal Reserve economists.[14] That may be an advantage when monetary policy is expansionary and on target but may be a weakness if policy misses during adverse conditions. It also means big mistakes move faster through the market than ever before.

What does this mean for how assets that have expanded outside commercial banks and away from the primary federal prudential regulators’ gaze? Time will tell.

Affordability and Sustainability Versus Price and Value

As the dust settled on the foreclosure crisis that followed 2008, the industry talked about mortgages differently. Affordability, sustainability, and skin-in-the-game became part of the mix. But what is the state of those principles today after a 13-year expansion?

Homeowners love rapidly increasing home prices. Homebuyers do not. Over the past 13 years, homeowners have done well with average home prices nearly doubling from 2009.[15] The average price of homes sold in the United States increased from $275,000 in the first quarter of 2009 to $525,000 in the second quarter of 2022.[16]

A homebuyer will pay nearly $2,300 more or about 112 percent more each month in 2022 for the same home purchased at the low point following the financial crisis in 2009, assuming the national average mortgage rate, insurance, and property taxes.[17] The following table breaks down the increase.

Table 1. Changes in Homeownership Affordability 2009 to 2022

	2009	2022
Average Home Price (Sold)	$275,000	$525,000
Average Monthly Payment	$2,040	$4,332
Average Homeowner Insurance Premium[18]	$880/year ($73/month)	$2,742/year ($229/month)
Average Property Tax	$2,887/year ($241/month)	$5,964/year ($497/month)
Average 30-year Mortgage Rate	5.79%	6.7%

Table assumes no PMI and no money down and is calculated using FRED and Census Bureau data. Mortgage rates used were at the end of the first quarter 2009 and third quarter 2022.

Homeowners association (HOA) and condo fees increasingly factor into affordability and sustainability and are up nearly a third since end of the last financial crisis and more homes are covered by those fees than ever before.[19] The national average HOA fee for single-family homeowners is $200 to $300 per month, while condo fees range $300 to $400 per month.[20] Rates vary dramatically by region, and some of the areas struggling most with affordability, such as New York City, Los Angeles, San Francisco, Boston and Chicago, also have the highest fees. New York sees the most expensive median HOA fee of $570 per month.[21]

HOA and condo fees are intended to return value to homeowners through services and amenities. That results in the homes covered by HOA or condo fees being valued about 4 percent more than homes in surrounding neighborhoods.[22] While selecting properties covered by HOA or condo fees is a personal choice, it is becoming more difficult to avoid with more than 82 percent of new homes sold in 2021 being covered by HOA or condo fees and more than half of all homeowners living in communities covered by HOA or condo fees.[23]

Factoring in HOA fees into the example described above increases the monthly out-of-pocket costs nearly 10 percent to cover the cost of owning a home (for the half of homes covered by HOAs in the country). That can push a home out of reach for many or force them to consider lower-priced homes.

This discussion of changes in affordability and sustainability excludes increased costs of home maintenance and other potentially significant changes during this period.

Cost is only one side to affordability and sustainability. Available income is the other. Prior to the foreclosure crisis, conversations about affordability often excluded total debt to income and what percentage of that debt should involve a mortgage. Following the experience of modifying millions of troubled mortgages following the last crisis, a plurality, if not a consensus, emerged that ideally mortgage debt should not exceed 31 percent of a borrower’s debt to gross income (DTI).[24]

Using the same example above and a 31 percent DTI, a borrower would need to have earned $6,581 per month ($78,968 per year) to afford the average home in 2009 while a borrower would need to earn $13,974 per month ($167,690 per year) today. Over that same period the average household income across the country increased from $82,210 in 2009 to just $97,026 at the end of 2021.[25] Said another way, in 2009 a family making the nation’s average annual income could afford the average home, but today that family would have to make 42 percent more than the nation’s average household income.

How will these changes in affordability and sustainability affect performance of mortgage portfolios and securities during the next recession? Still to be determined.

Mortgage Product Mix Has Changed Too, Or Has it?

The loan product villain in the last crisis was the “ninja” mortgage, requiring no job, no income, and no assets to qualify. When combined with low or no down payments, adjustable rates, and high loan-to-value ratios, these loans provided tinder that made portfolios explosive for investors and made loans riskier for many borrowers.

Among Alt-A securitizations in 2006, 80 percent of loans had limited or no documentation[26] and nearly 40 percent of mortgages originated that year had loan-to-value ratios of 97 percent or greater.[27] Within the worst performing securities at the time, nearly half of the originations were cash-out refis and almost 80 percent had adjustable rates (ARMs), often with interest-free introductory periods.[28]

Rather than being used for the best qualified borrowers as in the past, lenders began offering loans with these terms to borrowers with lower credit scores and greater risk of not fully repaying the loans. Setting aside factors driving that marketing change and mutual responsibility of parties entering contracts, the resulting increase in delinquency rates and foreclosures affected consumers and communities immensely. Then Michigan Law Professor Michael Barr criticized the government-sanctioned decline in underwriting standards and its impact on borrowers, saying, “For HUD to be indifferent as to whether these loans were hurting people or helping them is really an abject failure to regulate. It was just irresponsible.”[29]

After 13 years of economic expansion, comprehensive regulatory reform, conservatorship of the nation’s largest source of mortgage funders and securitizers, and a new federal agency dedicated to consumer protection, more creative mortgage products might be making a comeback.

And, the federal government appears to be helping fuel the renaissance with zero down loans from the VA and 3.5 percent down for borrowers with credit scores as low as 620 from the FHA. While these “limited” programs are set up to help homeowners afford the American dream and higher loan-to-value mortgages can improve credit accessibility particularly in areas with older surplus home stocks, these practices in the federal-sponsored space tend to set broader market trends in motion as risk migrates across the spectrum of borrowers and lenders.

That appetite appears to be growing.

ARMs, for example are on the rise. The Mortgage Bankers Association noted that in mid-2022, ARMs made up more than 10 percent of new originations, more than tripling since 2020.[30]

No-doc mortgages are surging, too, as any Google search for no-doc mortgages yields thousands of ads from mortgage financiers offering some form of the product. Many of the companies pitching their products ironically cite the laws passed after the 2008 crisis as reasons the loans are safer and different today.

But, how different?

All these mortgage products can make sense for responsible borrowers seeking to conserve cash, afford a more expensive home, or serve another legitimate financial purpose. Still, the accumulation of risk with these familiar practices at this point in the economic cycle will raise eyebrows now and second guessing by regulators and policymakers later.

Implication for Lenders and Investors

As the Federal Reserve projects additional rate increases[31] and the housing markets cool,[32] lenders, servicers, and investors should consider risks in their operations and portfolio now and what they can do to mitigate those risks.

Lenders and servicers should review existing guidance from regulators such as the OCC, FDIC, and CFPB regarding prudent risk management of residential real estate, loss mitigation actions, and nontraditional mortgages. Quality control at every stage of the mortgage lifecycle must be a focus for all market participants.[33]

Lenders and servicers should review existing workout policies and capabilities and ensure customer service functions are staffed and trained appropriately with effective scripts to assist customers. Institutions should verify such functions have scalability necessary to support an increase in demand for workout and assistance under stress. They should understand and manage risks presented by third-party service providers and partners. Originators, fintech and more traditional mortgage companies, should ensure stability of their funding lines and purchase agreements including potential “putback” risk, which cost institutions billions following the last mortgage meltdown.[34] They should, of course, ensure reserves are commensurate with the risks in their portfolios.

Lenders and servicers almost certainly will face greater regulatory scrutiny in the months ahead as periods of stress amplify operational weakness and erode asset quality. Failures in operational risk management following the last housing crisis resulted in customer service breakdowns and consumer compliance issues resulting in headline risk and will likely face escalating supervisory and civil actions next time as well.

Preventative steps taken at this point in the cycle will help ensure operations remain resilient and effective under more adverse condition.

Put Patomak’s Expertise to Work

Patomak has deep experience in helping banks and other financial institutions assess emerging risks related to public policy developments and market opportunities. Contact us to learn how Patomak can help you navigate these challenges and help you meet your business goals.

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[1] Prashant Gopal. “US Home Prices Now Posting Biggest Monthly Drops Since 2009.” Bloomberg. October 3, 2022.

[2] Physicist Richard Feynman famously demonstrated how O-ring failure at low temperature led to the space shuttle Challenger disaster. His analysis, however, also showed how complexity can mask risk, complicate its predictability, and obscure its visibility.

[3] “Comptroller Dugan Unveils New OCC Mortgage Metrics Report.” News Release 2008-65. OCC. June 11, 2008.

[4] “Agencies Release Joint Mortgage Metrics Report for the Second Quarter of 2008.” News Release 2008-105. September 12, 2008.

[5] Disclosure: Author Bryan Hubbard was directly involved in the creation and production for the OCC Mortgage Metrics Report for more than a decade and these comments reflect that first-hand experience.

[6] The agencies relied on data aggregator McDash Analytics, which was later acquired by Lender Processing Services, or LPS, in 2008. Fidelity National Financial acquired LPS in 2014, renaming it Black Knight Financial Services. Black Knight spun off from Fidelity in 2017.

[7] OCC and OTS Mortgage Metrics Report, January—June 2008. OCC and OTS. September 2008.

[8] John Dugan. Statement Before the Financial Crisis Inquiry Commission. April 8, 2010.

[9] OCC Mortgage Metrics Report, Second Quarter 2022. OCC. September 2022.

[10] Laurie Goodman. “Why you should care that private investors don’t want to buy your mortgage anymore?” Urban Institute. October 9, 2015.

[11] Brad Finkelstein. “Private-label MBS issuance to hit a post-crisis record in 2022.” National Mortgage News. November 15, 2021.

[12] “The Impact of Fintech on Mortgage Lenders.” Get Smarter. April 22, 2022.

[13] Di Maggio, Marco, Dimuthu Ratnadiwakara, and Don Carmichael. “Invisible Primes: Fintech Lending with Alternative Data.” Harvard Business School Working Paper, No. 22-024, October 2021.

[14] Xiaoqing Zhou. “FinTech Lending, Social Networks, and the Transmission of Monetary Policy.” Working Paper 2203. Federal Reserve Bank of Dallas. March 2022.

[15] This article focuses on average prices rather than median, recognizing that the median home price in 2022 was lower at $428,700 according to Federal Reserve Economic Data. Because average sales price is inflated by hotter, more expensive markets, the average sale price is more suitable for this discussion and reflects market risk better.

[16] Average Sales Price of Houses Sold for the United States. Economic Data (FRED). St. Louis Federal Reserve Bank. July 26, 2022.

[17] Calculated using average home prices and 30-year mortgage rates from FRED Economic Data.

[18] Average premiums for homeowners insurance in the United States from 2001 to 2019. Statista. April 12, 2022.

[19] HOA Statistics. iProperty Management. April 23, 2022.

[20] HOA Stats: Average HOA Fees & Number of HOAs by State (2022). Ruby Home. July 18, 2022.

[21] HOA Statistics. iProperty Management. April 23, 2022.

[22] HOA Statistics. iProperty Management. April 23, 2022.

[23] HOA Statistics. iProperty Management. April 23, 2022.

[24] After several iterations, guidelines used by the federal Home Affordable Modification Program set debt to gross income for modified mortgages at 31 percent. The FHA also considers 31 percent of gross income when qualifying borrowers.

[25]  Table A-2, Households by Total Money Income, Race, and Hispanic Origin of Householder: 1967 to 2020.  “Income and Poverty in the United States: 2020.” U.S. Census. September 14, 2021.

[26] Christopher Mayer, Karen Pence, and Shane M. Sherlund, “The Rise in Mortgage Defaults,” Journal of Economic Perspectives 23, no. 1. Cited in  The Financial Crisis Inquiry Commission Report. January 2011 (amended February 2011). p. 110.

[27] Peter J. Wallison. The Financial Crisis Inquiry Commission Report. January 2011 (amended February 2011). p. 494.

[28] The Financial Crisis Inquiry Commission Report. January 2011 (amended February 2011). p. 111.

[29] Carol D. Leonnig. “How HUD Mortgage Policy Fed the Crisis.” Washington Post. June 10, 2008.

[30] Peter Warden. “Adjustable-rate mortgages are back. But are ARMs worth the risk?” The Mortgage Reports. July 27, 2022.

[31] Irina Ivanova. “Federal Reserve hikes key interest rate 0.75 percentage point, projects economic slowdown.” Money Watch. CBS News. September 21, 2022.

[32] “As Mortgage Rates Climb, A Hot Housing Market Cools.” National Public Radio. October 3, 2022.

[33] Patrick Gluesing. “How the mortgage industry can mitigate risks in 2022.” SourcePoint. May 19, 2022.

[34] Ash Bennington. “Citi Could Face A $22 Billion Loss on Put-Back Mortgage Bonds.” CNBC. October 19, 2010.