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The mortgage origination rollercoaster continues to roll! After rising to stratospheric levels in 2020 and 2021, iEmergent forecasts that origination volume in 2022 will fall in its steepest decline ever, dragged down by a sharply contracting refi segment. Our latest forecast predicts that overall mortgage volume will decline by -35% from last year – a refi origination drop of -63% and a purchase gain of only 4%.
First, here is a summary of how economic events drove the mortgage origination industry to this point.
Pandemic: In 2020, the exploding COVID-19 pandemic brought much of the world economy to a standstill in a matter of weeks. Governments quickly enacted extraordinary monetary and fiscal policy stimulus efforts to combat the economic shock.
Stimulus: In the U.S., the Fed’s monetary stimulus included dropping short-term interest rates to near zero and buying nearly $5 trillion in government bonds and mortgage-backed securities to support credit markets (quantitative easing). Under the urging of both the Trump and Biden administrations, Congress passed fiscal stimulus bills pouring $4.6 trillion into the economy to support consumer and business spending.
Initial Result: We experienced an extraordinarily quick recovery – by most measures, the fastest and most robust in the world.
Employment: In April 2020, the unemployment rate had spiked to 14.7%, far surpassing the previous high of 10.8% in 1982. Now (May 2022), it is back down to 3.6%. Job openings now outnumber unemployed workers by almost 2 to 1.
Real GDP: From Q4/2019 to Q2/2020, GDP fell -10.1%, more than double the decline in the Great Recession. In Q3/2020, it bounced back like a rubber band, and by Q1/2022, it was up by 14.8% from its trough.
Interest rates: Long-term interest rates fell to record lows in 2020. From January 2020 to January 2021, 30-year fixed rate mortgages fell from 3.72% to 2.65%, igniting the biggest refinance boom ever and helping push purchase mortgage originations to record levels as well.
Longer-term Results: Pandemic-induced supply constraints, coupled with over-stimulated demand, caused upward pressure on prices. This pressure was further exacerbated by the Russia-Ukraine War – the second severe and unexpected shock to hit the world economy in the last three years.
Inflation: Core PCE index growth (personal consumption expenditures index excluding the volatile food and energy segments), which had been below the targeted 2% level for most of the last three decades, began ratcheting up in 2021. By February 2022, it hit 5.3% before falling slightly in March and April. Total CPI inflation peaked even higher, up to 8.6% in May.
Interest rate spike: With future dollars worth less, investors are requiring higher yields on long-term money. Ten-year Treasury bond yields topped 3% in early May with over 1% of that rise coming in the prior two months. Mortgage rates rose even faster and jumped above 6%, their highest since late 2008, and a steep jump from their 2.65% low last year. (See the green line in the chart below).
Fed tightening: Beating back inflation will be the Fed’s responsibility. It has raised the Fed Funds rate by 1.50% since the year began and will soon start reducing its $8.9 trillion balance sheet (quantitative tightening). Its aim is to slow the economy and reduce inflationary pressure without tipping the country into recession.
Now, almost halfway through 2022, mortgage originations have fallen steadily for over a year as the refi boom has waned. For the rest of 2022, we have dropped our refi segment decline to -63%, though we believe it is already approaching its baseline level. In 2023, we estimate a further refi volume decline of -26%.
On the purchase side, affordability is becoming a bigger constraint. Home price appreciation (HPA), has soared in the last two years (the rate of change on the blue line on the chart below), driven by (1) pandemic stimulus, both lower interest rates and federal recovery payments to households; (2) a demand shift towards homeownership and move-up buying spurred by more employees working from home; (3) the arrival of the bulk of the huge millennial generation to its prime homebuying stage of life; and (4) a dwindling inventory of homes available for sale.
The mortgage payment-to-income ratio is one measure of affordability. It goes up with interest rate increases and home price increases, and it falls with increases in household income. In our estimation, it is at its highest level since the housing price bubble of 2004-2008. To buy a new house now, we estimate it will take the median income household 28.5% of its monthly income to pay a mortgage on the median priced homes.
Given the growing affordability constraint and continued tight housing inventory, we estimate that purchase origination dollars will rise only 4% in 2022, entirely driven by an increase in average loan size. Purchase loan counts will actually decline -8% in our 2022 forecast, but there is a decent chance they could decline further. In 2023, we forecast that purchase volume will rise 5%, again driven primarily by increased loan sizes.
Our forecast assumptions are somewhat optimistic: (1) that mortgage rates do not rise very much higher than where they are now; (2) that the Fed tightening effort succeeds in reducing inflationary demand, but it also pulls the country into mild recession (which helps reduce long-term interest rates); and (3) that affordability cools home sales enough so that HPA begins to slow but doesn’t go negative.
Hang on – it could be a wild ride!