For most of the last 25 years, large annual swings in home mortgage originations have been common, driven by a refinance boom-and-bust cycle. And while refinance will continue to be an important segment of the market, home purchase is expected to dominate the lending landscape in the coming years. What this means for the lending industry is that mortgage volumes will likely be more steady on a year-to-year basis.Home sales and home-purchase lending vary each year and are largely affected by the business cycle and the level of mortgage rates, but that variation is far less than the year-to-year change in refinance. Comparing annual origination’s since 1990, the standard deviation of refinance was about triple that of home purchase. The cause of this heightened variability has been the gradual disinflation in the U.S. economy over this period leading to a sequence of ever-lower mortgage rates.
Historically, each time the mortgage rate reached a new low, it triggered a wave of so-called “rate-and-term” refinancing. These are homeowners who elected to refinance to lower their mortgage cost, shorten their term or do both. The universe of potential refinancers are all owners with a mortgage. Since 2000, this population has generally been around 50 million homeowners, and the number of refinance origination’s has varied from as little as 1 million to as many as 14 million loans per year. Compare that with the number of home-purchase loans, which has varied between three million and seven million per year since 2000, and it becomes clear why a refinance “boom-and-bust” tied to the ups and downs in mortgage rates has caused the wide annual swings in past lending.
Projections of home mortgage lending reveal a “new normal.” Mortgage volumes will vary each year, but the large peaks and valleys of the past are far less likely in coming years. That’s because the historic period of economic disinflation that began in the early 1980s is behind us, and lower inflation expectations have translated into lower interest rates. The Federal Reserve has indicated it would prefer slightly more inflation, with a target of 2 percent inflation per year, and that it expects to increase short-term interest rates in the future. Thus, mortgage rates are expected to rise.
With the average interest rate on mortgage debt outstanding at about 3.8 percent, and with mortgage rates generally projected above 4 percent in 2017 and beyond, refinance will diminish to a much smaller share of the lending market. Current forecasts show the refinance share by 2018 at or near the lowest percentage since the late 1980s. Thus, the large swings in annual lending that have characterized the market will likely be substantially lessened. This market characteristic – less annual lending volatility – will likely be part of the “new normal” for the lending industry.