Fintech’s Erosion of the Mortgage Monolith
Fintech lenders have a lot going for them; over the past six years, the market share of online lenders quadrupled, while the value of mortgage debt in the United States swelled to $14.9 trillion. In 2016, online lending behemoths Quicken Loans and loanDepot increased their total loan dollar amounts originated by 22% and 40%, respectively, as a direct result of faster loan processing, increased customer satisfaction, and aggressive marketing.
Contrast this with former industry titans, Wells Fargo and Bank of America, who saw stagnating growth of 5% and 1.72% respectively over that same period. In the wake of numerous lender scandals, banks have seen their ability to lend curtailed by government regulation and consumers hostility. Ironically, the one place where big banks did rank highly was on the list of lenders with the most consumer complaints in America. Fintech lenders have a lot to gain from missteps made by banks during the last recession.
Today’s home prices exceed their 2006 peak and continue to climb, thanks to a lack of supply and glut of homebuyers. However, rather than ascending to the golden throne of mortgage lending, banks saw their market share eroded by a growing collection of fintech competitors in the last few years. In late 2017 and early 2018, Quicken Loans actually surpassed banking triumvirate: Wells Fargo, Bank of America and Chase Bank, as the No. 1 originator of residential mortgages by volume.
Industry experts view this as a fundamental transformation in the way mortgage lending is conducted. Traditionally, mortgage underwriting is a labor-intensive process that requires the coordination of a team of loan officers, underwriters and support staff. Fintech lenders have largely automated this origination process, cutting application processing times to mere minutes instead of days, and closings to a matter of weeks rather than months.
But are these changes really as drastic as the headlines make them out to be, or does the fintech boom still have a long way to go before they become the de facto industry leaders? The Federal Reserve Bank of New York recently published a study that evaluated the impact of fintech lending practices and whether they’ve actually reduced any “frictions” in the mortgage industry. We examine some of their key findings below.
Reduced Closing Time
Fintech lenders were found to reduce the number of days it took to close home purchases by around 7.5 days when compared to traditional lenders. In terms of refinancing, the difference was even more compelling, with 9.3 days shaved off from the closing process on average. This makes a world of difference in an industry where the typical closing process used to take as long as three months.
Contrary to traditional mortgage lending, where local loan officers and underwriters manually review each mortgage application, fintech lenders reduced the evaluation process into a series of algorithms. This allowed loan officers to focus on customer service and reduced the amount of time and effort spent verifying details. On average, the study found that borrowers were significantly more likely to experience faster closings with fintech lenders than brick-and-mortar banks.
Lower Interest Rates
The notion that fintech lenders charged cheaper rates than banks was up for debate. In the study, fintech lenders were found to offer interest rates that were approximately 7.5 basis points (0.075%) lower than traditional lenders. This razor-thin margin reflects a highly competitive national lending industry across not only fintech, but credit unions and banks as well. Borrowers shouldn’t be so quick to write off traditional lenders just yet.
A popular argument of fintech proponents is that online lenders can offer lower rates due to increased efficiencies and reduced overhead. While the study may have confirmed this to a degree, rates vary daily on a case-by-case basis, and it’s difficult to draw substantial conclusions based on a figure under a quarter of a percentage point, as the experimenters themselves concluded. This finding was even more inconclusive in refinancing, where fintech lenders were found to offer no discernible advantage in rates when compared to traditional lenders.
The study found that the presence of fintech companies seemed to lead to higher incidences of refinances, and more specifically, “an increase in the rate of refinancing for borrowers who would gain the most from doing so.” The experimenters concluded that fintech companies seem to correlate with more frequent and optimal borrower refinancing, possibly due to reduced costs, fewer obstacles, or increased market penetration.
In a separate study published under the Journal of Financial Economics, approximately 20% of households failed to refinance their mortgages when it was optimal to do so. While the current market for refinancing is in cyclical decline due to the gradual hike in interest rates, at the least, fintech lenders seem to have reduced the barriers that stand in the way of refinancing. If this trend continues, it could mean the transfer of millions of dollars of interest savings back into the pockets of consumers.
A common opinion is that fintech lenders cater disproportionately to millennials and poor-credit borrowers. This is due to the idea that millennials are more comfortable with technology, and the perception that regulations are more lenient for nonbanks. Interestingly enough, the study results found neither to be the case.
Poor-credit quality mortgages from fintech companies actually registered lower rates of default than similar mortgages from traditional lenders. Fintech lenders were able to reduce the number of fraudulent applications and lower the number of defaults, through their reliance on electronic verification procedures. This matches borrower stated information with data obtained from public records, which led to fewer errors when compared to manual verification done by traditional lenders.
Where millennials were concerned, older borrowers were actually more likely to use fintech lenders than younger first-time homebuyers. The study concluded that older borrowers who were familiar with the homebuying process were more comfortable applying online for an online loan. By contrast, first-time homebuyers preferred to complete their mortgage applications face-to-face, due to their relative lack of experience. The so-called “digital divide” was found to have no significant correlation with a borrower’s likelihood to use a fintech lender.
Where Do We Go From Here?
While this study had only a decade of data to rely on, it’s likely that these trends will continue to evolve over time. Depending on how things materialize, the line between fintech firms and brick-and-mortar banks could very well become blurred, as big banks move to further adopt the digitized lending practices of fintech firms. As a fundamental law of economics, no competitive advantage is likely to continue unexploited for long; it remains to be seen whether fintech will continue to roll out new changes as fast as the banks can capitalize on them.