Incumbents must digitize their backend operations and loan origination process to cut costs and compete against new entrants.
By the end of 2017, nearly $1.8T worth of mortgages will have been originated in the United States this year, according to government-backed mortgage lender Freddie Mac.
Yet, despite the size of the mortgage industry, the space still hasn’t digitized. Originating, processing, and underwriting a home loan with a large bank lender still requires faxes and snail mail and take almost as long as it did 20 years.
Given the size and profitability of the industry, mortgages have lately become a prime target for tech entrepreneurs and venture capitalists.
The impact of tech on the mortgage market is still in the early innings. In this analysis, we examine what mortgage tech is, what its impact will be on incumbent players and fintechs, and the key drivers creating a big opportunity in mortgages now.
What is mortgage tech?
Mortgage technology startups are companies that apply digital processes to mortgage origination, underwriting, servicing, investment, and other associated business activities. The graphic below highlights several of the prominent technology startups now active across the mortgage industry.
Click the image to enlarge.
Using the CB Insights Trends tool, we see that the amount of media attention on digitization and technology in the mortgage industry is on the rise.
Why is mortgage tech taking off?
Driver 1: New lenders increase the competition
Non-bank lenders are becoming much bigger players in mortgages. In 2011, three banks accounted for half of new mortgage loans, according to the Washington Post. As of September 2016, that share dropped to 21%.
In 2011, just two of the top 10 biggest lenders were non-bank lenders. In 2016, non-bank lenders like Quicken Loans accounted for six of the top 10.
Banks have receded from mortgage lending for a host of reasons, principally because the cost of complying with strict regulation from the Consumer Financial Protection Bureau on loan qualification and capital requirements has made the business more expensive.
In addition, loan-guarantee fees charged by Fannie Mae and Freddie Mac are now uniform for banks and non-bank lenders, whereas previously banks paid less.
This has allowed non-bank lenders to be more competitive, and in a bid to gain more customers, lenders of all stripes are now competing based on differentiators like customer service.
Quicken Loans is a large player that was early to digitization, and has built up a formidable digital loan product with its Rocket Mortgage.
Quicken Loans founder Dan Gilbert’s innovation in mortgages was to assign regional-specific loan application reviewers, who familiarized themselves with the regulations of certain geographies. This helped navigate fragmented regional regulations.
Its mortgage lending business has grown quickly of late in part because of its asset light, internet model, lending $96B in 2016, up from $12B in 2008.
Because Quicken Loans’ charges higher-than-average lending rates, it has focused especially on customer experience as a differentiator.
In 2015, the company launched Rocket Mortgage, a desktop and mobile loan application process that streamlined financial document and information sharing, sped up approval to minutes, and let customers lock in interest rates.
In 2016, Rocket Mortgage funded $7B in loans, 7% of the total loan volume for Quicken Loans. Eighty percent of those customers were first-time home buyers and millennials were twice as likely to use their product as a competitor.
Regis Hadiaris, Product Lead for Rocket Mortgage, explained at CB Insights’ Future of Fintech conference, how the company approaches digital mortgages.
“If we think about the experience, it’s really about how we get to know a consumer and their goals as quickly as possible. In order to offer online solutions, we must first understand their property, income, assets, and credit. And so, instead of taking people through long questionnaires and trying to figure this stuff out, we can now use data. We can import data for most properties in the United States. We can import and analyze bank account information and digitally verify assets and income on the spot. We’ve seen our fastest clients in Rocket Mortgage go from creating an account to signing closing papers in 9 days in a refi[nance] and in 16 days on a purchase.”
Driver 2: Incumbents are looking to improve their technology
Incumbents in the mortgage space are recognizing that they must improve their archaic processes and are looking to digital players to help them adapt.
The push for digital mortgage applications is being driven by a shift in consumer behavior and expectations. Digitally fluent home buyers are entering the market and expect a digitized loan process. In addition, lenders are also looking to speed up their processes and cut costs using faster digital tools.
“Consumers in general, not just millennials, are pushing the home financing industry to go digital because they have already experienced and have come to expect the ease of use and level of service that comes with 24/7 access and a digital experience,” according to Nick Stamos, CEO and founder of Sindeo, a mortgage technology company.
At an average cost of $7,000, originating and processing a loan takes over 400 pages and more than 25 humans working hundreds of hours across 50 days. Of the total, approximately $5,000 can be attributed to human processing costs.
Even after a tremendous amount of back and forth, in-person signings add an extra layer of friction to the process. Daunting expectations about the process alone can delay or deter customers from taking out a mortgage or refinancing their existing mortgage.
In a survey conducted by Fannie Mae, 46% of polled lenders said that origination was an investment priority, citing pain points in their current technology providers, gaps in online & mobile application capabilities, and general automation capabilities. One half said their primary goal when investing in origination technology was to improve the borrower’s customer experience.
Approved and Blend are two companies focused on digitizing lenders’ back-office operations through improved document collection, digital application forms, CRM systems and reminders, and e-signature capabilities that are mobile friendly and which can be white labeled. Both companies also say they effectively secure the user data they collect.
Blend uses technology like optical character recognition to grab data from documents a user uploads. Blend CEO Nima Ghamsari, speaking at the Future of Fintech, explained how the company has improved the origination process from manually determining and entering a borrower’s assets, income, and credit history.
Improved infrastructure for data sharing in the financial services industry allows a user to “authorize the bank to go and get your financial data with your permission, aggregate it…it’s machine-readable data, it can run directly against their underwriting models, it’s verified. And that means that all of the friction in the transaction of understanding my financial picture is going to zero.”
Driver 3: Individuals’ debt burden forces them to find alternative lenders
Burdened by student debt and costly urban rent-rates, first-time, millennial home buyers in the US are struggling to manage their personal finances to qualify for home loans. Most importantly millennials are failing to build up the requisite capital for a down payment.
As Wharton professor of real estate and finance, Susan Wachter explained:
“The expansion of non-banks in response [to the decline in bank lending] is a good thing, but we’re still missing a million or more homeowners, in part because many millennials are still not able to get credit through traditional means. For good or bad, consumers with marginal credit scores and unverifiable income are out of the market now.”
People’s assumption that millennials simply aren’t interested in home ownership is wrong. Eighty percent of millennial renters want to buy a single-family home or apartment, but 72% cannot afford to, according to survey data from Apartment List.
The trends in national homeownership and renting prove this out, as both homeownership and rental vacancy have decreased since the Great Recession.
Although total US homeownership has risen to 64% as of Q3’17, when examined by age group, the percentage of homeowners under 35 years old is only 36%. This is down from 44% in 2004.
A significant contributor to this trend is recent growth in outstanding student debt.
Whereas $516B of student aid was held outstanding by 28M Americans in 2007, by the third quarter of 2017, $1.337T of debt was held by 42M Americans. This means that the average student debt held by individuals grew 75% from $18k to $32k.
According to the National Association of Realtors, 46% of home buyers that are 36 years or younger that have debt reported a median loan balance of $25,000.
When combined with high urban rent rates, this debt burden makes saving for a down payment a significant challenge. Young buyers are caught in a Catch 22; the longer it takes to build up the capital for a down payment, the more a home appreciates in value and, in turn, the larger the requisite down payment.
According to estimates by Apartment List, 68% of millennials have less than $1,000 saved for a down payment.
But the millennial generation is a massive market and they are still finding ways to buy homes. Despite the above, 34% of home buyers were younger than 36 in 2016, making millennials the largest home buying generation according to the National Association of Realtors. Of that age group, 98% financed their home purchase.
A number of technology startups have emerged offering products aimed at millennials that do not fit the traditional borrower profile.
SoFi, which initially offered student debt refinancing, has expanded into mortgages and other financing products as well. SoFi reports funding over $25B in student loans to 400,000+ members, offering savings up to $288 a month.
Apart from helping refinance student debt, SoFi also provides members with a host of investment and career advice. SoFi has positioned itself strategically at the beginning of a potential homebuyer’s customer journey by settling a member’s debt burden and helping to stabilize their personal finances.
SoFi customers are offered loans with as little as a 10% down payment without private mortgage insurance, loan origination fees, or loan pre-qualification.
Better Mortgage is another leading company in the space. Better provides 24-hour verified pre-approval letter within 24 hours and up to $50K towards a home buyer’s good faith deposit with a seller, which helps customers better compete against all-cash offers. It also boasts 0% commission loan officers and considers restricted stock and self-employed wages when qualifying a customer’s loan, making it an attractive lender to employees of small companies and those who run their own businesses.
Some companies offer products exclusively focused on addressing the challenge of saving for a down payment.
Loftium has entered the market to offer products that take advantage of flexible income practices like home-sharing. Loftium provides customers with a down payment with no interest on a home purchase in exchange for a future share of home-share revenue from platforms like Airbnb until the loan is paid down.
Similar products could eventually be offered by Airbnb, and even public corporations like Priceline (Booking.com), or Expedia (HomeAway), down the line.
Who should care?
Bank lenders and incumbents that are slow to improve their technology will lose out if these new mortgage companies gain greater market share and offer smoother processes and faster results at lower or similar cost.
Shifting consumer behavior around technology, consumer debt profiles, and earning patterns have created an opportunity in the mortgage market. Incumbent lenders are struggling to adequately serve digitally native millennial customers and have challenges determining customers’ credit-worthiness. Additionally, innovation is coming to areas where investment has been lower, such as loan servicing, regulatory compliance, and underwriting.
The home-buying process is changing, as a new generation of consumers with a higher debt burden begins to purchase homes and enters the market with an expectation of easy-to-use digital processes. Incumbents must make investments to improve the customer experience for new borrowers. Simultaneously, new entrants will be factoring in more holistic customer profiles as they look to gain a share of the mortgage lending market.
In 10 years, the loan process will likely look very different than today. The question is will the makeup of top lenders have shifted as well.