Affordability and the Pull Back Effect

QUESTION 

I read your article last week on selling mortgages when rates are high. At my company, we are stuck in a sales malaise because our borrowers are facing high housing prices. Newspapers are calling it the "affordability ceiling." Whatever you want to call it, our borrowers are holding back. 

We can find workarounds for the rate, but there's nothing we can do about affordable housing. 

In today's sales meeting, we passed your article around about the rate issue. Now, we could use some feedback on why it is so difficult to sell mortgages due to affordability issues. Please be straight with us. We need answers! 

Why is affordability causing mortgage sales to slump? 

SOLUTION

AI FOR MORTGAGE LOAN ORIGINATION - SALES MANUAL

Most AI advice for loan officers is either a feature list with no compliance grounding, or a compliance memo with no growth plan. This sales manual is both — a chaptered, action-checklist playbook that follows your actual sales funnel from first contact to lifetime retention. Every recommendation accords with applicable regulatory compliance standards.  

ANSWER 

Affordability 

Let's start with an understanding of the word "affordability" in its common use. The current administration has been stating that it is a new media term invented by the political opposition. This misinformation has gone so far as to portray "affordability" as a "con job" or "hoax."[i] 

The word "affordability" is not an invented media term. The Oxford English Dictionary shows this noun dates back more than a century to the 1910s. It is obviously derived from the verb "afford" and the suffix "-ability." While the word itself is old, its heavy saturation as a primary political buzzword surged significantly during recent election cycles to describe cost-of-living pressures. 

For this article, I define "affordability" as the financial ability of people or households to pay for essential goods, services, or assets – such as housing, healthcare, or education – using their available income without going into severe debt or sacrificing other basic needs. 

The way I see it, affordability relies on a balance between what things cost and how much money a person or family earns. It means a person has enough money left over for basic living needs after paying for a major necessity. From an underwriting perspective, using credit may make something temporarily accessible, but true long-term affordability depends on sustainable future income. 

Affordability Ceiling 

And, yes, there is an "affordability ceiling." This is an informal economic term that gained prominence in the early 2000s. I first saw it in market analyses involving real estate and also in financial journalism articles. 

I would define the “affordability ceiling” as the maximum price, rent, or cost that buyers and renters can realistically afford based on their incomes. Once this limit is reached, consumers can no longer absorb price hikes, forcing changes in market behavior like downsizing or moving.

Now, let's go deeper into answering your question! 

The Combination Punch 

Home prices and mortgage rates are both staying high at the same time, and that combination is what's really squeezing buyers out of the market. That's quite a combination punch! 

Unfortunately, there is a core math problem: The median single-family home hit an all-time high of $440,600 in July, up 1.8% from a year ago, with prices having risen for 36 straight months. Meanwhile, mortgage rates haven't come down much. By June, qualifying for a mortgage on the median-priced home required $109,152 in annual household income, up from $93,552 in January, a $15,600 jump in just five months.[ii] The fact is, wages simply haven't kept pace with that kind of increase. 

Add to that the obstacle of rates rising alongside home prices. NAR calculates that in June, buyers needed to borrow at an effective rate of 6.57% (including points and fees), up from 6.19% five months earlier.[iii] Even modest rate upticks translate into real lost buying power. Indeed, one analysis found homebuyers lost about $11,000 in purchasing power between February and April alone, as rates moved from around 6% to 6.3%.[iv] 

The result of this combo punch is a reduction in closings and an increase in contract fallouts. It takes a higher percentage of applications to land a single sale. The purchase pull-through rate recently dropped to 78.9%.[v] As to contract fallouts, roughly 14% of pending sales fell out of contract in July. This is happening because borrowers struggle to meet debt-to-income (DTI) requirements or back out due to payment shock.[vi]

Selling Mortgages in a High Rate Environment

QUESTION 

We have been watching mortgage rates rise and rise, yet there seems to be no end in sight. I am a loan officer with a large mortgage lender. My pipeline has been shrinking due to the rate rise. This is not my first ride on the interest rate roller coaster – I got into this game in 1997 – but it seems much more uncontrollable now, more difficult to explain to my customers. 

I can't look them in the eye and give them a good explanation other than what we all read in the news. This is getting serious. At our sales meeting, we tried to come up with a sales strategy to explain why rates are rising and, really important, how we originate loans in such an high rate environment. 

Your name came up because you have many clients and can shed light on how lenders are grappling with the high rates that are causing borrowers to postpone financing plans. You have a broad perspective and could share some ways to help our customers move forward. 

What can we tell our borrowers about why rates are rising? 

SOLUTION 

AI FOR MORTGAGE LOAN ORIGINATION 

Most AI advice for loan officers is either a feature list with no compliance grounding, or a compliance memo with no growth plan. This sales manual is both — a chaptered, action-checklist playbook that follows your actual sales funnel from first contact to lifetime retention. Every recommendation accords with applicable regulatory compliance standards. 

ANSWER 

Like you and many others, this "is not my first ride on the interest rate roller coaster." In fact, my roller coaster ride goes all the way back to the 1970s. In those days, we went from about 7% in the early 1970s to over 11% by 1979. But rates continued to rise! By the early 1980s, the rate was over 16.5% and stayed in the double digits for most of the decade. But I know of loan rates then going to over 18%. When rates came down to about 10% in 1989, we broke out the champagne! 

And now? The 30-year fixed is averaging 6.58%. 

As the saying goes, "context matters." I took my handy HP 12c, calculated the average rate on 30-year fixed mortgages, and laid out the possible contributing factors. I think my outline provides some perspective. 

Here's my take on things. In the 1970s, the average 30-year fixed rate was 8.9%. The rate peaked in 1981 with an annualized average of 16.6%, and for the whole decade the average was 12.7%. 

But context matters! In 1970, the median sales price for a single-family home was $23,900; in the 1980s, it jumped to between $46,200 and $76,000 (depending on new construction vs. existing home sales); and in the 1990s, home prices rose again to between $79,100 and $149,442. 

And now? The average SFR price is hovering over $521,000. 

So, to put a fine point on it, in 1980, a homebuyer facing a 15% interest rate was borrowing against a principal that was only roughly 2 to 3 times the average household income. Today, a buyer facing about a 6.6% interest rate is often borrowing a principal that is 5 to 7 times the average household income! This makes the modern monthly mortgage payment highly sensitive to even minor interest rate fluctuations. 

On to your question!

You ask the compelling sales question about the current mortgage rate: how to explain to your borrowers why the rates continue to rise? I will answer with some economics and offer a few ways to keep a trusting relationship with borrowers. 

The first step is to address the economic reality. No equivocation. No politics. No mincing words. Borrowers know when a sales pitch is creeping into a discussion on economic reality. In the most important long-term investment of their lives, they are sensitive to nuances. You are not a forecaster, but you can be direct and clear. 

My view, which I give below, is not a forecast and should not be relied on for tax, accounting, regulatory, legal, insurance, or investment advice. I hope it helps to improve your ability to provide excellent service to your customers at the point of sale. 

WHY ARE RATES ELEVATED RIGHT NOW?

The immediate driver: bond yields, not the Fed directly.  

The 30-year fixed rate rose to 6.81% last week, the highest in a year, reflecting a surge in global bond yields after Fed Chair Kevin Warsh offered little guidance on whether or when the Fed might raise rates to combat elevated inflation. Given that kind of response from the Fed Chair, it is no wonder your customers are a bit skittish. 

Mortgage rates track the 10-year Treasury yield far more closely than the Fed funds rate itself, and that yield has been climbing. So what are the underlying causes?

How to Prepare for a Global Recession

YOUR COMPLIANCE QUESTION 

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I am the CFO of a Mortgage REIT, a residential mortgage lender, and a mortgage servicer. Our board met to discuss what could happen to our mortgage originations in the event of a global recession. Our secondary and capital markets department is already gearing up for a recession. Our loan originations were affected by rising rates – and not in a good way. Our margins have been compressed, and hedging is difficult. 

Your name came up in the meeting, as one of the board members knows you. The thought was that you have many clients and probably have a good idea about the overall condition of the mortgage banking industry and how it can prepare for a recession. Because of your place in compliance and risk management, she feels that you could shed light on how we can prepare for a recession. Thank you for considering our question! 

How can a mortgage lender protect itself in a global recession? 

OUR COMPLIANCE SOLUTION

AI POLICY PROGRAM FOR MORTGAGE BANKING™  

Our AI Policy Program aligns with Freddie Mac's AI governance requirements for Freddie Mac Sellers/Servicers. Responsible AI practices can help align AI system design, development, and use with applicable legal and regulatory guidelines. 

Our AI Policy Program consists of the following policies:  

1.      Artificial Intelligence Governance Policy

2.      Artificial Intelligence Use Policy

3.      Artificial Intelligence Workplace Policy

4.      Artificial Intelligence Credit Underwriting Policy

5.      Artificial Intelligence Do & Do Not Policy

6.      Artificial Intelligence Ethics Policy

7.      Artificial Intelligence Vendor Management Policy  

Contact us for the presentation and pricing!  

RESPONSE TO YOUR QUESTION 

Our clients often discuss how their compliance failures result in direct financial losses. During a period of financial stress, a lender scrambling to address compliance deficiencies while also managing credit losses and liquidity pressures faces a compounded crisis that can accelerate failure. In this article, I want to address your specific question about what happens in mortgage banking in a global recession and how to prepare for it. 

Compliance Amplifies Everything 

Let me state at the outset that compliance during a recession amplifies everything! Specifically, in a recession, the compliance-stability connection intensifies because: 

• Regulators increase examination frequency and scrutiny, 
• GSEs conduct more aggressive post-purchase file reviews, 
• Borrower complaints rise sharply, triggering CFPB investigations, 
• Desperate borrowers and originators increase fraud risk, making compliance controls more critical, 
• Investors have less tolerance for defects and push repurchases more aggressively, and 
• State attorneys general become more active in mortgage enforcement. 

A lender entering a recession with a strong compliance foundation is dramatically better positioned than one carrying hidden violations that regulators and investors are about to discover. 

Fundamental Rule 

Here's the fundamental rule to planning for a recession: 

Lenders who prepare during good times survive recessions;

lenders who assume good times last forever do not. 

The 2008 crisis wiped out hundreds of mortgage companies that were profitable just 18 months earlier. The ones that survived – and thrived afterward – had built conservative balance sheets, diversified channels, and operational flexibility long before the storm arrived. 

Let's zoom out to the implications of a worldwide recession on mortgage banking. Understanding its impact on the banking ecosystem will give us a perspective on how a lender can protect itself in a recession.

Explaining Interest Rates to Borrowers

QUESTION 

I am a new loan officer working for a mortgage broker. I graduated from college two years ago, and I still live with my parents because I can't find a decent job. A friend became a loan officer and said I should do it too. So, I got involved as a side hustle. I've been doing this for nine months. 

At this point, I have made loans for a few family members and a good friend, and I have 6 loans in the pipeline from real estate offices. My borrowers always talk about the rates. It's probably their number one question. They then ask me to explain how rates are determined. No matter how I explain it to them, they get confused, and I don't blame them. The rate is always changing and seems unpredictable. 

How should I explain interest rates to my borrowers?

Thank you! 

A Newbie Loan Officer 

OUR COMPLIANCE SOLUTION

We recommend:

LENDERS COMPLIANCE GROUP, established in 2006. It is the first and only full-service, mortgage risk management firm in the United States. It specializes in residential mortgage compliance and provides the largest suite of compliance solutions for banks, non-banks, credit unions, independent mortgage professionals, and mortgage servicers. 

BROKERS COMPLIANCE GROUP, the first full-service, mortgage risk management firm in the United States. It specializes in outsourced mortgage compliance and offers a full suite of services to mortgage brokers and mini-correspondents. 

OUR ANSWER 

For my response, I am going to assume that your loan applicant is not particularly interested in the secondary and capital markets, the factors that determine mortgage rates, or the securitization factors that affect them. 

That said, I am going to assume that you want a straightforward explanation that you can provide to your loan applicants. I hope to offer a non-technical view that they will understand while you are sitting with them to take the loan application. 

As a new loan officer, please note that when the applicant is sitting down to take the application (or interacting with you online), the point of sale is often a make-or-break moment. 

The point of sale is the most important part of loan sales because it is the primary point where trust is established between the loan officer and the applicants. If you can't explain how mortgage rates are determined, you can lose their trust in your expertise, a factor that could determine if they go with you or somebody else. 

Components that Determine Mortgage Interest Rates

There are essentially two significant components that determine mortgage interest rates: market and economic conditions, and what I'll call personal and lender-specific influences. 

Let's consider each of them. 

Market and Economic Conditions 

Several market and economic factors affect the baseline for all mortgage rates and are largely outside a borrower's control. 

Let's discuss! 

Bond Market & Treasury Yields 

Mortgage rates are directly tied to the yields on U.S. Treasury notes, particularly the 10-year Treasury yield, and mortgage-backed securities (MBS). These are considered "safe havens" for preserving financial assets. When investor demand for these safe-haven assets increases – most often during times of economic uncertainty – yields, and thus mortgage rates, tend to fall. Conversely, low demand pushes rates up. 

Now, this may confuse your borrowers. So, you should tell them that these financial instruments work inversely to interest rates because their "fixed coupon" payment becomes more or less valuable as new such financial instruments offer different rates. So, when market rates rise, existing bonds with lower fixed payments become less attractive, and their prices fall to a competitive yield; and when rates fall, existing bonds become more valuable, and their prices rise. This inverse relationship means if you sell an old bond when rates are up, you'll get less; if you sell when rates are down, you'll get more. 

Inflation 

High inflation leads lenders and investors to demand higher interest rates to offset the erosion of the purchasing power of future payments. When inflation is low, rates tend to be lower. 

An example would be when high inflation prompts the Federal Reserve to raise interest rates, making mortgages more expensive (for instance, from 3% to 6%). Hence, a buyer of a $300,000 home pays more monthly, and when investors demand higher yields on bonds to compensate for their future earnings, they buy less. At the same time, low inflation allows for lower borrowing costs, stimulating spending and investment.