Today, nearly three-quarters (72%) of credit unions' total revenues come from interest income. So, when interest earnings as a percent of assets dropped almost 30% in April of this year, more than one alarm bell sounded within the movement.
Credit union leaders across the country are rightly concerned about the sustainability of mortgage lending within what is already a highly competitive environment. In fact, lending executives participating in a May 2022 MGIC survey ranked the expected difficulty of 2022 at an eight out of 10. And while shiny startup strategies for boosting interest income make the headlines, it may be the resurgence of a traditional mortgage lending product that makes the difference.
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Borrowers Give ARMs a Fresh Look
We're talking, of course, about the adjustable-rate mortgage. Although the product took a reputational hit during the housing crisis of 2008, a new segment of borrowers views ARMs as both affordable and relevant to their lifestyles and financial goals. In June, the Mortgage Bankers Association reported that the ARM share of applications had jumped to over 10%.
Here are a few reasons why we suspect ARMs are resonating with today's homebuyer.
Homes are expensive: The low-down-payment financing of ARMs make homeownership possible sooner for many borrowers, especially now during a period of accelerating annual home price appreciation. During the last 12 months, home prices rose 20.9%, the fastest pace on record.
Costs of borrowing money is increasing: Rising interest rates impact a homebuyer's monthly mortgage payment, making the lower-rate ARM products much more attractive, especially as inflation puts added pressure on individual and family budgets. Mortgage interest rates have recently risen to over 6%, as the Federal Reserve ended its purchases of mortgage-backed securities. In July 2022, the contract interest rates on a 30-year fixed-rate conventional home mortgage rose to 5.3%, up from 4.2% in March and much higher than the 3.3% reported in July 2021. 5/1-Year ARMs, however, had fallen to 4.19% by July 2022.
Equity grows faster: In addition to lower monthly payments, the lower interest rate means that initially more of the payment is going to principal, accelerating home equity and wealth creation for ARM holders.
Product structures are flexible: Much more flexible ARM products, such as those that offer initial fixed periods of five, seven or 10 years, appeal to a broader segment of the marketplace – especially borrowers of a younger generation, who expect to live in their homes for fewer years than older generations.
Transparency is increasing: ARMs are typically underwritten much more strictly today than during the last housing boom. Fully documented ARMs, the standard among today's credit-union underwriters, have added greater transparency and confidence to the product segment overall.
Lenders Join Borrowers in Reconsidering ARMs
Participants in the May 2022 MGIC survey ranked the importance of ARMs to the housing market at a seven out of 10. Credit unions, too, are rethinking ARMs as an essential piece of the mortgage lending product pie.
Particularly in light of new entrants to the marketplace, ARMs represent a significant competitive differentiator. Non-depositories and other independent lenders must consider the ultimate marketability of their loans. Credit unions, on the other hand, have the flexibility to design loan products that make sense for members after the American dream, rather than shareholders after investment-level returns.
Today's ARMs are also accompanied by proven risk-mitigation practices. Private mortgage insurance (PMI), for example, has paid claims through more than six decades of financial cycles. Partnering with a mortgage insurance provider provides both an expert independent view of mortgage risk and easy-to-implement product guidelines to meet today's borrower needs.
The fact of the matter is today's borrowers have an incredible set of options for home mortgages. Increasingly, they are placing their trust in non-traditional financial providers to move them along the path to wealth faster. As credit unions find new ways to remain relevant with younger consumers who expect greater flexibility, speedy achievement of goals and personalized service, an ARM may be just the thing to pull them in. Capable of attracting a high-contributing segment of new members, the product may also boost much-needed interest income along the way.
Kevin Hearden
Kevin Hearden is Director, Product Development for MGIC in Milwaukee, Wis.
Steve Rick Steve Rick is Chief Economist for CUNA Mutual Group in Madison, Wis.
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