Can technology make the mortgage process better?
With record-low interest rates and the great remote work domestic migration driving home refinancing and purchasing activity respectively, the United States mortgage market has heated up significantly throughout the COVID-19 pandemic. In fact, the $3.8T worth of mortgages originated over the past year has cemented 2020 as the largest year for mortgage origination volume ever in the United States. This surge in mortgage activity prompted us to consider the opportunities and challenges associated with this massive, but relatively understudied area of proptech. In speaking with homeowners, lenders and other industry experts, it is evident that the mortgage process is (still) a grind. We see a big opportunity for startups to (keep) innovating in this part of the real estate transaction.
Understanding the historical and current impact of technology on the mortgage value chain is critical to identifying why mortgage represents a compelling investment area today. After much analysis, our view is that enormous opportunity exists when it comes to the back end and managing the mortgage after the transaction. There are still questions around who owns the relationship with homeowners and how data can be used far more effectively than it is today. We’ll dive a little deeper into why we’ve concluded that the back end of mortgage is an area to watch.
A short history of the mortgage
For the 60%+ of American homeowners who had to take on a loan to purchase their house, mortgages are a necessary tool to achieve homeownership and the American dream. The average down payment in the United States is below 10%, so most Americans finance their home purchase with 90% debt. This access to attractive leverage is driven by the federal government backstop on most residential mortgages; Uncle Sam deeply subsidizes homeownership.
Was this always the case? In short, no. In our view, the American mortgage has 3 distinct eras; pre–Great Depression, Great Depression — 2009 and post-2009.
Mortgages in the pre–Great Depression era were restrictive — they required high down payment (50%+), interest only payments over a shorter time period (typically 5 -7 years) and required a large balloon payment at the end. Lending was concentrated in the hands of a few banks and the involvement of the federal government was limited.
After the Great Depression, America underwent an era of economic prosperity. The government became more involved in the housing market and the mortgage product became more user-friendly; longer payback periods, lower down payment requirements and generally more flexible terms. This second era of American mortgage culminated in the Great Financial Crisis (GFC). Lax (read non-existent) underwriting standards resulted in a rise in riskier mortgages; which were then marketed and sold as high-quality investments to end investors such as pension funds and insurance companies. As more borrowers began to default on home loans that they could not afford, the credit markets seized up and there were widespread ramifications across the global economy.
Coming out of the financial crisis, we are currently in the third era of the American mortgage — which is characterized by widespread institutional PTSD from 2009. Regulation was introduced to heighten underwriting standards and the regulatory burden is now significantly higher for lenders. Large traditional consumer-facing banks have spent the decade pulling out of the residential mortgage market — replaced by non-bank originators such as Rocket Mortgage.
There are a couple of notable takeaways from the history of the American mortgage. First, there has been consistent ebb and flow between expanded and restricted access to credit. Given the stricter loan structure and underwriting regulation post-GFC due to inappropriately expanded credit, the pendulum has swung the other way. As a result, the main innovations in mortgage technology over the past decade have been process innovations (ie. a faster horse) vs. product innovations (ie. a car).
“Mortgage innovation over the past decade has been predicated on digitally accepting data, automating processes and improving each step of the client experience”. Jeremy Potter, Rocket Mortgage
Second, we’ve also seen a steadily increasing role of government in the residential house financing market — a trend that shows no sign of relenting given recent federal moratoriums on foreclosures during COVID-19. The federal government will always play a key role here and innovation occurs under their guise.
Alongside the evolution of the American mortgage, we have identified three broad waves in the mortgage technology space.
The initial phase of technological innovation focused on a) digitizing workflows and b) aggregating leads. Software products such as Encompass (Ellie Mae) and Empower (Black Knight) became entrenched in key workstreams — similar to Bloomberg for financial professionals or Salesforce across corporate America. Even today, both these products remain the clear incumbent winners in their respective software verticals.
This initial phase of innovation was coupled with sites such as lendingtree and creditkarma which allowed for mortgage originators to begin to acquire a customer online.
Following the initial focus on process digitization and lead generation, the second wave focused on applying technology to the existing mortgage rails — making people-centric processes more efficient. This concept gave way to the emergence of a cohort of originators — either full-stack lenders or brokers who wanted to acquire and process consumers as digitally as possible. In addition to this group of originators, there were notable point solution providers such as Blend that emerged to bring slick, consumer facing UX tools to a legacy industry. Blend, in particular, has enjoyed enormous success — achieving ~30% market share, a $3.3B valuation & recently filing to go public.
Today, we find ourselves amid mortgage technology 3.0. This third wave of innovation takes a technology-centric approach to the origination process itself; the goal is to reduce the human touch and further drive throughput efficiency.
“To date, the mortgage industry has been structurally designed to rely on humans”. Dan Green, CEO of Homebuyer
Alongside originating efforts, mortgage tech 3.0 brings a shifting focus towards the long-neglected back end of mortgage technology; optimizing the mortgage funding plumbing and bringing much needed technology to the long-tail servicing relationship.
According to Eric Rachmel, CEO of Brace, “servicing is the next endeavor in mortgage as the workflows are complex and inefficient today.”
Why are we interested in mortgage technology?
As a derivative of the overall residential housing market, the mortgage market is a massive area of opportunity. The recent surge in both re-financings and purchase activity has both a) highlighted the antiquated processes and opportunities to improve workflows and b) re-upped investor conviction in home ownership. And with the recent fundraising successes of Blend and better.com, mortgage technology is gaining momentum and attracting top notch founders tackling various issues across the entire value chain. We are also seeing the continued development of a mortgage technology ecosystem — founders peeling off from successful start-ups to solve other problems in the mortgage process.
Below we have mapped out the current mortgage technology landscape.
So where is the opportunity?
As we mentioned earlier, to date a lot of the innovation in the mortgage space has focused on the front end of mortgage, around acquiring customers and originating the loan. We still see opportunities in the front end around enabling more predictive customer acquisition strategies, improving the underwriting and processing workflows and the emergence of a 21st century loan origination system. Based on the saturation to date, our attention has turned to the back end, specifically the servicing side.
Once the loan is closed, the lender typically sells the loan to the secondary markets, but this is just the beginning of the relationship with the borrower. This is where the servicer comes in. Servicers manage the monthly payments for the term of the loan. The effort required to service loans varies significantly depending on the borrower situation — for performing loans this can be as simple as collecting payments, for non-performing loans there is a whole host of responsibilities that fall on the servicer such as repayment modification plans, lien release and handling borrower communication. When it comes to the future of servicing, all our conversations to date make us bullish on three key areas:
1. Owning the homeowner relationship: currently this relationship is severely under optimized which creates the potential for technology to help servicers strengthen this relationship and provide a more holistic picture of the consumer’s financial position
2. Workflow and data structuring: there are lots of opportunities to optimize workflows in this sector or parts of the loan servicing journey to make it more automated and streamlined
3. Modern loan management system: replacing the full system or managing the full process is significant, but expect to see players gradually make headway here, especially as servicers build their brands resulting in new forms of customer preferences and competition
We believe that there is tremendous opportunity to build in the mortgage space. Home ownership is still central to many American’s aspirations and the mortgage is the key tool to make that dream a reality. If you are building in the mortgage space, we would love to chat!
And if you are interested in seeing what else we are focusing on it the proptech space, check out our other posts on the future role of the commercial real estate broker, how people are thinking about a return to the office more than one year on from global lockdowns, and our thoughts on whether the construction sector is truly ready for disruption.