Easing Worried Homebuyers with Lender Optionality

Calling the 2022 housing market a roller coaster may be overstated, but that doesn't necessarily mean it's not true. The year was a tale of two halves, with historically low rates seeming to be a thing of the past as inflation-busting tactics by the Federal Reserve caused rates to increase throughout the year. While last year was unique, each year brings its ebbs and flows to the housing market. It’s nearly impossible to predict exactly what will happen within this year’s market, but we’ve compiled some insight to help you prepare for 2023. Will Home Prices Drop? Prospective buyers’ eyes typically gravitate towards a few features when shopping for their next home: location, square footage, the number of bedrooms and bathrooms, and perhaps most importantly, price tag. While the dollar amount on a home doesn’t exactly equate to its affordability, any potential price drops next year could encourage individuals to begin their homebuying journey. Which begs the question: will home prices drop in 2023? 2022 was a case of two halves. Using data from July, the Case Shiller index reported a drop in home values for the first time in 2012. However, with that drop in value, the market also saw fewer listings. That lack of supply brought a slight uptick in value to end the year as 2022 finished with an increase of 8-10% in home value year-over-year in many according to insight from John Toohig, Managing Director & Director of Whole Loan Trading at Raymond James. All this to say, a continued downtick in supply will likely see prices trend in the opposite direction. What Will Happen With Mortgage Rates? Throughout the year the Federal Reserve has steadily increased the Federal Funds Rate to fight inflation, which has also brought a steady increase—amidst some general volatility—in mortgage rates throughout the year. The biggest key factor to bring a decrease in rates in 2023 will be unemployment rates. “Unemployment remains the last opponent to Fed Reserve Chair, Jerome Powell’s, rate hike,” said Toohig. “If we see weakness in wage growth and in the unemployment rate, we’ll start to see rates come down even faster.” The 2023 housing market may bring its own challenges, increasing the importance of the places individuals look for their home loan. UMortgage loan originators can create life-changing opportunities through homeownership for many homebuyers through the platform’s better pricing, lender optionality, more-intuitive tech stack, and dedicated support staff. If you’d like to learn more about how UMortgage can help you increase your business in 2023, sign up for the weekly Discovery Meeting hosted by Anthony Casa and a rotating cast of UMortgage’s top talent.

It comes as no surprise to anyone in touch with the current state of the housing market to say that rates are concerning to the average home buyer. These rates have a significant trickle-down effect on every other facet of real estate; housing market demand has seen a sharp decline with prospective home buyers worried about market volatility and a speculated housing market crash. Although the majority of prospective home buyers remain hesitant to engage with the housing market in its current state, UMortgage Loan Originators have been able to ease worried home buyers with access to a broad portfolio of different lenders and the loan products at their fingertips. Options like the 2-1 temporary rate buydown, non-QM loans, and Down Payment Assistance programs are helping UMortgage Loan Originators combat off-putting and erratic mortgage rates to help create the life-changing opportunities that come with homeownership. With the help of UMortgage’s Capital Markets team that is constantly sourcing for competitive products and partners offering their loan originators creative solutions, UMortgage recorded back-to-back record weeks for loans locked in the final two weeks of September. “The optionality that I get at UMortgage helps my business tremendously,” claims Daniel De La Torre Roffe, Branch Manager of Ultimate Mortgage Team Powered by UMortgage. “We have many different ways that we can structure a transaction. If pricing is better on a particular lender, then we can send our loan to them versus another lender. Additionally, the loan programs available to us give us more control over the transaction as a whole and provide our referral partners and borrowers with an experience which I couldn’t provide before joining this platform.” Products like the 2-1 buydown are creating a more manageable path towards homeownership for qualified borrowers by buying down the prospective home buyer’s rate by two points for the first year of the mortgage and one point for the second year. “The 2-1 Buydown Loan was a great tool to help my clients get into a home, afford the payment, and not stretch so much in the first couple of years,” said Todd Davidson, a UMortgage Loan Originator based in Oregon. “As the payment increases each of the following two years, so should the buyer’s increased payment. If rates go down, as expected, they can refinance to make that payment more affordable for them.” With the wide scope of products available and the nuances of the mortgage process, home buyer education has become a cornerstone of success for many Loan Originators. Brian Barkowski, Branch Manager of Ironbank Mortgage Powered by UMortgage, has leveraged his platform on social media to share his knowledge of the housing market and the benefits of homeownership with prospective home buyers. But having access to a library of loan products is only half the battle, UMortgage Loan Originators lead with expert advice winning over more clients by educating them on the importance of homeownership, regardless of market conditions. “We’re not just closing loans and getting people mortgages, we are actually helping them realize what that home does for them in the long run,” said Barkowski. “Owning a home is so much more than just providing a roof over your head. The equity that you’re building is one of the greatest avenues to achieve generational wealth. By providing these facts and putting client education at the forefront of everything we do really helps us stand out from the crowd.” Through holistic client education on the mortgage process, Barkowski aims to keep homebuyers optimistic in regards to the housing market. By emphasizing the benefits of building equity and opportunities to refinance, Loan Originators can make an effort to change the narrative that it’s a bad time to buy a home. The statistics don’t lie, though. In September, Fannie Mae’s latest Home Purchase Sentiment Index indicated that 75% of consumers believe that it’s a bad time to buy. This downtick in home buying demand has led many mortgage companies to cut costs and lay-off large portions of their staff. UMortgage is doing the opposite, having hired 112 Loan Originators in Q3 of 2022. By utilizing creative solutions to combat the volatile market, the Philadelphia-based mortgage platform had +40% Lock Volume Growth Quarter-Over-Quarter from Q2 to Q3 (99% Purchase). With proper education and a full suite of competitive loan products, buying a home can become a much less daunting process for many prospective home buyers.

Introduction There are a multitude of factors that work in tandem to determine how mortgage pricing is determined and what products lenders can offer borrowers. In these subsequent pages, this paper will expand on the relationship between consumer loan pricing and capital market conditions while addressing some of the common misconceptions of how loans are priced. It will also illustrate the process involved in generating consumer loan offerings and intermediate loan prices. In short, mortgage backed security (MBS) market prices are incorporated with multiple other factors to value alternative execution options. Once able to determine “best execution”, lenders will calculate the prices at which loans will be offered to consumers, and the prices that correspondent lenders will pay for loans originated by smaller primary lenders. While it can be useful to contemplate the impact of MBS and mortgage spreads on primary loan offerings, spread levels aren’t incorporated into loan pricing methods. Rather, MBS prices combine with a few other factors to drive loan valuations and consumer loan pricing. This document will examine how these processes work and will demonstrate how the various factors interact with each other when generating loan pricing. These insights are important in understanding the process of generating loan offerings and the factors that drive changes in consumer mortgage rates. The data in this document is sourced from a piece titled The Links Between MBS Markets and Loan Prices written by Bill Berliner, Director of Analytics at MCT—a capital markets advisory firm based out of New York.  Common Misconceptions The relationship between consumer loan pricing and capital market conditions is commonly misconstrued within the mortgage industry. One misconception is that mortgage rates are dictated by rate spreads. Loan pricing methodologies can’t directly utilize the MBS spread or any such output to generate their mortgage rate matrices. It’s more accurate to view changing MBS spreads as a coincidental result of the relative performance of MBS and Treasury prices rather than as a major driver of mortgage rates. Additionally, there is a common misconception that lenders offer consumers ‘rates’. It is important to note that lenders do not directly generate or offer rates. Rather, they calculate and offer prices for a given range of note rates. This concept is vital to understanding how mortgage rates are generated. How is Consumer Loan Pricing Calculated? The methodology used to generate consumer loan prices utilizes a combination of inputs and factors. Pricing for fixed-rate loans is typically calculated for a range of note rate strata centered around a perceived rate level. There are two primary steps necessary to generate loan pricing: • Determine the best-execution coupon for each note rate level • Calculate the all-in price at each rate either as a price or as discount points paid by/credited to the borrower The examples that we’re using utilize 30-year conventional loans. It’s also helpful to keep the economic structure of the mortgage market in mind. Pricing derived from securitized execution is the standard for which pricing at other levels is derived. Cash Flow Allocation of Loans Before we dive into the nitty gritty of coupon-best execution, we’re going to review the allocation of a loan’s cash flow within an MBS. All of the principal is paid to the bondholders while the borrowers’ interest payments go to three different destinations: • Servicing: When you’ve provided a loan to one of your clients, you’re pretty much done with the loan itself (keep developing that relationship with your clients though!). But someone’s got to ensure that the loan is paid and that the funds are sent to the right places. That’s where the servicer comes in. They’re not going to do all of that work for free, so mortgage securitization programs stipulate that ‘required’ servicing is held to compensate them for their work.  • Guaranty Fee: You might also know these as “g-fees”. These are payments made to an agency such as Ginnie Mae, Fannie Mae, and Freddie Mac in exchange for providing credit support for the issued security. For around the last decade, g-fees hover around 45 basis points for UMBS, and this is the figure we’ve used in our examples. • Pool Coupon: Fixed-rate MBS are almost always created with coupons. In even 50 basis point increments. The coupon rate is the interest paid to the holder of the MBS based on the remaining principal value of the security. UMBS pooling rules specify that the note rates of loans must be at least 25 basis points above the security’s coupon rate and at most 112.5 basis points higher than the pool’s coupon. This means that every note rate can be pooled through two possible pool coupons. When pooled down, the cash flows from the loan are allocated to required servicing and g-fees, which may result in some excess servicing. When pooled up into the higher allowable coupon, there usually isn’t enough interest to cover the required servicing and g-fees. Therefore, some or all of the g-fee must be “bought down” or remitted to the government-sponsored entity (GSE), such as Fannie Mae or Freddie Mac, as a lump-sum payment when the pool is created. Figure I demonstrates how cash flows for a conventional loan with a 3.375 rate can be allocated using the methods explained above. As you can see, when assuming 25 basis points of required servicing and a 45-basis-point guaranty fee, pooling up into a UM 3.5% passthrough results in a shortfall of 32.5 basis points. In this case, the g-fee shortfall must be bought down by paying a lump sum to Fannie Mae or Freddie Mac. The amount of the payment is calculated using a buy-down multiple provided to the securitizing lender by the GSEs. For example, if the multiple quoted is 5x, the 32.5 basis points buyout equates to 1.625 points on the par value of the loan and is paid directly to the GSEs. Pooling down into a UM30 2.5% passthrough leaves 17.5 basis points of excess servicing in this figure. In this case, the GSEs might buy the excess interest at a lower multiple. For example, if Fannie quoted a 4x multiple, they would pay the lender 0.7 points to purchase the cash flow. FIGURE I: Cash Flow Allocation for a Loan Being Slotted Into UM30 2.5% and 3.0% Pools From time-to-time, GSEs facilitate the pricing process by providing approved MBS issuers with “Buy-up/Buy-Down” grids which display the multiples at which the buy-up or buy-down transactions can be executed. Figure II is a hypothetical example of a buy-up/buy-down grid for a 30-year fixed-rate mortgage with note rates shown in 12.5 basis point increments and multiples shown for a range of remaining maturities. Buy-up and buy-down multiples typically decrease as note rates increase—this reflects the negative impact of faster prepayments on the value of interest-only cash flow streams. Figure II: Hypothetical Example of a Buy-Up/Buy-Down Grid for 30-Year Fixed-Rate Mortgages Calculating Coupon Best-Execution The first, and generally the most important step when generating loan pricing for each note rate is to calculate its optimal execution. In other words, the MBS coupon rate that generates the maximum proceeds from securitization. Figure III shows a hypothetical example of the process for a loan with a 3.375% note rate. Based on current pooling rules, the loan can be pooled into either a UM30 2.5% or 3% pool. When pooled through a 2.5% pool, the loan creates 17.5 basis points of excess servicing which can either be sold or retained. The 3% pool requires buying down 32.5 basis points of the g-fee. Based on the example figure, it would indicate that pooling down into the 2.5% pool offers better execution by approximately half of a point. Figure III: Coupon Best-Execution Example This example shows that there are multiple inputs and assumptions that drive analysis. Some of the key factors include: • The price of the two TBAs. The dollar prices in figure 3 differ by 1 and 14/32nds. Expanding on this ‘coupon swap’ would tend to push execution towards the “pooling up” scenario. • The level of the “g-fees”. Although a 45 BPS assumption is consistent with industry standards, it’s important to note that prior to 2010, g-fees were about half of their current levels. Higher g-fees mean that “pooling up” into the higher coupon requires more of the g-fee to be bought down. Because buy-down multiples are typically higher than buy-up multiples, higher g-fees will typically skew the execution toward pooling down. • The levels of the buy-up and buy-down multiples. As noted, Figure 3 indicates that 32.5 basis points of the g-fee needs to be bought down if the loan is pooled into the 3s, while 17.5 basis points of excess servicing are created by pooling into 2.5s. As a result, both the absolute and relative levels of the multiples impact execution. For example, if both multiples are increased to 4.5x, the execution advantage of pooling into 2.5s increases to 81 basis points; decreasing both multiples to 2.5x makes UM30 3s the best-execution option by about 19 basis points. While Figure 3 displays the value of required servicing to convey the concepts of g-fee shortfalls and excess servicing, it’s important to note that the amount and value of required servicing doesn’t change for the different coupons and in turn, doesn’t impact the execution. Margin and expenses also don’t impact the best-execution calculations since they don’t vary based on the execution. The calculation has also been simplified for conventional loans by the Single Security Initiative. Previously, best execution often needed to be established with both Fannie Mae and Freddie Mac as pooling options. The creation of a single UMBS security makes it unnecessary. Conclusion This document illustrates the processes involved in generating consumer loan offerings and intermediate loan prices. Mortgage pricing is determined by inputs including MBS prices, servicing valuations, guaranty fee levels, and buy-up/buy-down pricing provided by the GSEs. Lenders exercise the most control over their profit margins, which they use to tweak their profitability and control their volumes during periods of heavy origination activity. As part of its dedication to provide its Loan Originators with top-of-the-line resources, UMortgage has a dedicated Capital Markets team which keeps its finger on the pulse of the market and assists our LOs and Operations team throughout the loan origination process. If you're interested in this or any of the other ways that UMortgage is helping its LOs amplify their business, sign up for the weekly Discovery Call, which happens every Thursday at 2pm EST.