Homeowners in the U.S. were on track to refinance their mortgages to the tune of about $800 billion in 2019, according to estimates from the Mortgage Bankers Association (MBA). That’s a substantial increase over the $467 billion in refinance volume the mortgage industry saw in 2018. This made for a bumper year for mortgage originators and their companies.
The lingering question is, how long will the refinance boom last? For practical purposes, the wave will end when interest rates rise to the point where it’s no longer attractive for borrowers to refinance, or when a vast majority of borrowers who can benefit have chosen to refinance. The MBA expects the latter scenario to occur.
The U.S. has seen two other major refinance booms in the past decade that coincided with similarly low rates, although each subsequent one has been slightly smaller, says Joel Kan, the MBA’s associate vice president of economic and industry forecasting. In 2012, the mortgage industry saw nearly $1.5 trillion in refinance volume. In 2016, there was about $900 billion in refinance volume.
“You can see, we have these moments of lower rates,” Kan says. “We’re just not seeing the same kind of refi response. Not to say that it’s not a big year. It’s still a huge year — $800 billion in refis is a lot for the industry.”
Refinances are expected to remain strong through the first two quarters of this year — with another $362 billion in activity — before slowing to about $237 billion in the second half of 2020, according to MBA forecasts. Meanwhile, average interest rates, with some variation, are on a path to slowly rise before topping the 4% mark by 2022, Kan said.
About 26.5 million homeowners have an interest rate of 4% or higher on their 30-year mortgages, according to Black Knight, which provides technology, data and analytics to the real estate and mortgage industries. That represents half of the nation’s 53 million active first-lien mortgages.
Black Knight estimates there are 8 million homeowners who would be ideal prospects to refinance. Under their admittedly conservative-leaning parameters, the company defines these candidates as anyone with a 30-year mortgage and 20% equity in their home who also has a credit score of 720 or higher and who could save 75 basis points off their current mortgage.
Homeowners reacted to falling rates throughout 2019. Refinance origination volumes doubled during a nine-month period of last year, says Andy Walden, Black Knight’s director of market research. Even so, some homeowners continue to remain on the sidelines.
There’s always going to be a baseline level of refinance activity, because there are other reasons that people refinance aside from just rate arbitrage.
– Joe Mellman, senior vice president and mortgage business leader, TransUnion
“There are a number of potential factors that could be keeping borrowers from refinancing,” Walden says. “One possibility could be that homeowners simply aren’t aware of the savings available to them through refinance.
“Others may see the cost to refinance and the breakeven point on payments to be a deterrent. Others may be several years into their mortgage and may not want to ‘restart the clock.’”
The market remains highly sensitive to even small rate movements. For example, a decline of one-eighth of a percentage point on the 30-year rate would result in 1.5 million homeowners gaining the incentive to refinance, Walden says.
When this run eventually ends, the mortgage industry will face some of the same challenges it had before the refinance wave began, Kan says. For instance, lenders are likely to see the same pressure on profits they faced at the end of 2018 and the beginning of 2019.
The purchase-loan market, however, presents a couple of reasons for optimism. With millennials and Generation Z potentially flooding the market in the coming years, demographic factors tend to favor the purchase market. Housing inventory also is finally beginning to loosen as more homes are becoming available.
Will the projected increases in the purchase market offset the decline in refinances? Probably not, says Joe Mellman, senior vice president and mortgage business leader at credit-reporting agency TransUnion.
“It’s important when we think about when refinance [volume] is going to taper off, that it’s not going to drop to zero,” Mellman says. “There’s always going to be a baseline level of refinance activity, because there are other reasons that people refinance aside from just rate arbitrage.”
The current refinance boom could cause potential problems in the future, Mellman says. Typically, firsttime homebuyers will stay in a house for five to seven years before moving up to a nicer neighborhood or a more expensive home.
If interest rates tick up, however, it’s possible that those homeowners who locked into a low rate today will be unwilling to move in the future. If a homeowner has a current interest rate of 4%, for example, a 1 percentage-point increase in rates means they would be paying 25% more in interest if they took out a new mortgage. That’s a double whammy if that borrower is considering a more expensive home.
“What we may end up seeing is a lot more consumers staying in their first home as opposed to moving up,” Mellman says. “That in turn is going to put pressure on first-time homebuyers, because now you don’t have this natural vacuum of people leaving the affordable housing stock and moving into more expensive housing stock.”