Fintech Impact - A Long Way to Go
Given its press coverage, one would conclude that financial technology (fintech) has all but taken over residential real estate and its financing. However, a new report from Jung Choi, Karan Kaul, and Laurie Goodman of the Urban Institute (UI) states that the online share of all home sales (to owner-occupants, investors, fix-and-flippers, and others) is less than 15 percent. Compare this to other online shares; book sales, 55 percent; music, 80 percent; electronics, 35 percent.
The authors point out that buying a home is complex and time-consuming, heavily regulated at all government levels, involves multiple stakeholders, and is highly consequential to households' financial well-being. Despite these barriers, technology has made inroads, helping consumers build credit and save for a down payment, search for and purchase a home, shop for and obtain mortgage financing, navigate mortgage servicing, and extract home equity to eventually sell the home.
The UI study classified homebuying into phases; pre-buying, buying and selling, mortgage searching, mortgage lending, and post-purchase. It also grouped the transformations by fintech firms into two categories; improved efficiency and reduced structural barriers. The first is defined as automating manual business functions to improve accuracy and speed, reduce costs, and expand consumer access to information. The second includes changes driven by new products that tackle such structural problems as a lack of housing affordability, inadequate access to credit, and a lack of efficient mechanisms to monetize home equity
They found that fintech triggered transformations across all five phases, but the impact has varied. While it has made visible contributions to improving efficiency there has been little progress toward easing structural barriers.
UI's report identifies specific companies active in the fintech space. Rather than naming them, we have merely cherry-picked some of their more interesting innovations in each of the five UI homebuying phases.
The Pre-buying Phase
Households need to be financially prepared to attain and sustain homeownership and the fintech innovations here are all aimed at reducing barriers to doing so.
In the area of building credit and saving for a down payment, one on-line service consolidates a household's loans, assists in building savings, and makes loan payments on the consumer's behalf, prioritizing debts to hasten reduction of the debt load.
Another is a high-tech twist on the old rent-to-own scenario. A consumer identifies a home in which they wish to live. One of several fintech companies in this space buys the home and leases it to the family, setting aside a percentage (25 percent is quoted by UI) of the rental payments which goes toward building equity. At the end of the lease, the family has the right to buy the home at a predetermined price, converting the "equity" accumulated into a down payment or cashing it out if they decide not to buy.
FICO ran the credit scoring game for years but has gotten a lot of competition recently. FICO and its competitors have enhanced their technology and modeling techniques and incorporated some additional data into the credit scoring process. They have new programs that allow those with limited credit history to utilize bank statements, rent history, cell phone payments and so forth to build scores. While lender acceptance of these new models is still limited (and prohibited by government programs), their use is being investigated by Fannie Mae and Freddie Mac.
The Buying and Selling Phase
In this phase, the focus has been on enhancing efficiency and of course, customers have gotten used to researching neighborhoods, schools, and available homes on-line. UI says real estate agents still show homes to consumers and provide advice, but the initial search occurs online for the most part.
Fintech "iBuyer" firms are now trying to streamline and speed things on the selling side. They buy homes for cash, make necessary repairs, and sell the property through various channels, allowing sellers to receive proceeds quickly and move out sooner. Studies do not agree at this point if this service raises or lowers the sellers' return.
Another service provides cash to homeowners to purchase a new home, manage the sale of the old one, and settle the transaction, collecting its money at closing. The cash offer increases homebuyers' likelihood of obtaining their desired home and eliminates the need to sell their old home before buying a new one. A similar service purchases the existing home and rents it back until the seller is ready to move.
The Mortgage Search Phase
This phase has a couple of sub-categories, online mortgage counseling, mortgage research and shopping, both of which are considered to be efficiency enhancers, and home purchase financial affordability, which falls into the barrier reduction category.
Homebuyers often have outdated ideas about mortgages such as the level of downpayment required. The GSEs have taken the lead in this area with user-friendly interactive platforms to educate homebuyers and each has partnered with a variety of fintech companies to do so. UI says these platforms can empower potential homebuyers to buy at better terms, sustain long-term homeownership and reduces the information asymmetry between lenders and borrowers.
As they shop for a new mortgage, homebuyers can compare rates and products online and start the application process by submitting an application and connecting with a nationwide network of lenders. This is an efficiency compared with the old practice of calling brokers for rates and options, submitting multiple applications, often relying on paper, phone, email, and fax.
Some companies are also experimenting with shared appreciation products to reduce the upfront costs of buying. These products allow buyers to reduce their mortgage or increase their down payment in exchange for sharing a portion of future home price appreciation. These products have gotten the most traction in areas with high house prices; areas where even modest homes cost more than conventional loan limits.
The Mortgage Lending Phase
This is where fintechs have their biggest presence, and the authors list several dozen new and old entrants. These firms, all classified as efficiency enhancers, have reformed the mortgage lending process from application to underwriting, documentation, appraisal, and closing by automating data collection and verification, streamlining documentation, and facilitating online disclosures and electronic signatures.
While some of the companies are digital lenders, using technology to improve the process from application to approval and closing, others focus on increasing the speed and availability of traditional lenders. Forms needed for asset verification have been digitized, fintech companies can examine tax returns of self-employed borrowers to find and retrieve data points most relevant to underwriting and perform analytics to create metrics based on borrower income, debt, and other financial information that loan officers can readily consume.
There are platforms that allow lenders to directly retrieve borrower information such as bank statements, pay stubs, and tax forms, reducing the time and costs of gathering the same information from borrowers via phone, email, or fax, and improving the accuracy of underwriting. One such platform guides borrowers through the mortgage process (similar to online tax preparation software) and asking questions to generate a loan file with minimal human interaction.
The authors say that due to competition, traditional banks and mortgage lenders have struck partnership with fintech companies to produce online or app-based interfaces to originate loans. One recent study indicates that 45 percent of the 2000 largest mortgage lenders have done so.
Fannie Mae and Freddie Mac, use sophisticated automated valuation models to generate home price estimates as part of their underwriting and risk management and appraisal management companies now use automation to make appraisal assignments and facilitate delivery of the report. There is a pricing tool that provides county-level current and historic market data and others that allow appraisers to sketch floor plans and calculate square footage, create aerial maps, and analyze market conditions.
There has also been progress in the closing space and most closing functions can be generated, transmitted, and signed online. There is a cloud-based title and closing platform that unifies various title and escrow functions, such as reporting, documentation, email accounting, task management, and customer and vendor management.
The Postpurchase Phase
Fintech companies are also beginning to offer products to households after they become homeowners. This includes companies that offer mortgage servicing and home improvement products, home equity lending options, and homeowners' insurance. Most of these provide more efficiency, either offering those homeowner products directly or facilitating lending for their purchase.
The Bottom Line
Where have all of these new services had an impact and where are there gaps to be filled? UI says studies show that the speed of processing mortgage applications for fintech lenders is about 20 percent faster than non-fintech lenders although traditional lenders are adopting the technology.
But technology has its limits. Prospective homebuyers research homes and neighborhoods online and see what homes are on the market and at what price, but most eventually use a local real estate agent to guide them through the purchase. Sellers follow a similar path. Fintech firms are attempting to disrupt this market by buying or selling homes online, but it remains a niche market. UI says it is too early to tell how comfortable consumers will be going totally online with their biggest financial decision. In the short run, technology is likely to coexist with and complement face-to-face transactions.
Fintech also has limits within mortgage lending. The online mortgage application is usually picked up by a loan officer for further processing and to verify receipt of required documentation. A human is needed to walk the borrower through the process and various options. Although major technological innovation has taken root, mortgage differs from applying for a credit card or auto loan where the entire process from loan application to approval is completed online in a few minutes.
It is also unclear exactly who the fintech firms serve. One study found fintech lenders were more likely to lend to non-metropolitan residents with fewer choices and lower borrower credit scores. This suggests they may be penetrating previously underserved markets. Other studies find the opposite. There are also indications that fintech lenders have rates 14 to 16 basis points higher than traditional banks.
Both fintech and non-fintech lenders charge higher interest rates to black and Hispanic than to white borrowers with similar credit characteristics and those with low incomes. UI says additional study is required to understand why this is true. One potential reason is the fragmented nature of the mortgage market with credit availability and pricing largely dictated by the holder of the risk. That is, although fintech firms are simplifying lending, they are not necessarily the ones deciding how much credit risk to take and how much to charge for it.
As far as reducing structural barriers, the focus there is to offer new products such as those previously mentioned to help build credit, provide financial assistance, and extract home equity. While this is no doubt progress, the authors say, innovation has been lacking when it comes to approving more creditworthy borrowers for mortgages because of less lender willingness to take on credit risk, increased bank capital requirements, and more stringent regulation.
One factor is the costs of both origination and servicing. Although automation has helped mitigate it, the origination cost per loan, at well over $8,000, is still too high and servicing, despite major cost escalations, has remained largely devoid of fintech innovation. Nonperforming loan servicing, where costs are highest, is largely a high-touch, labor-intensive function that has proven difficult to address through technology.
Lastly, there are still gaps in using the latest available data to score mortgage applicants. One of these is the lack of rent payment date from credit reporters and also payments for telecom, cable TV, and utilities. Though the latter is reported to a comprehensive database covering over 300 million accounts and 200 million customers their use in the mortgage market is not permitted by the federal agencies and regulators that oversee it.
Some explanations for these gaps are again due to the fragmented structure of the mortgage market with its multiple actors; brokers, aggregators, lenders, servicers, and the ultimate holder of risk, usually the federal government. Each actor controls only a portion of the process, may have little incentive to improve the whole of it, and different views of how it all should work.
The authors conclude that there has been substantial technical innovation in the mortgage ecosystem and clear benefits for consumers, but major gaps still exist. In some cases, market structure and regulations have kept innovation from reaching its full potential, other functions may be too difficult to automate. There are targeted opportunities to expand innovation and serve more consumers by improving access to credit, streamlining mortgage servicing, and providing a better level of service.
More or less coincidental with the UI report was one from Fannie Mae regarding its lender survey which indicates they consider "consumer-facing technology" to be their most important priority to maintain competitiveness. We will recap those findings in a separate article.