Mortgage lending in a seller’s market


If community banks continue to use common sense and their proven methods of mortgage lending techniques, they should be able to ride out the twists and turns of the real estate market.

By William Atkinson

There is no question these days that when it comes to residential real estate, it’s a “seller’s market,” and prices are high. How can community banks continue to make good lending decisions based on these escalating prices?

The first question on many bankers’ minds is whether there any indications that the home market may crash again as it did a decade ago. It is very unlikely in the near future, according to Ron Haynie, ICBA senior vice president of mortgage finance policy. “There is nothing in the cards like there was 10 years ago,” he says. “Rates are stable, the bond market is strong, and we’re not anticipating any runaway inflation.”

Mortgage interest rates are about 1 percent higher than they were in 2017, and, according to Haynie, rates may rise another 0.5 percent in the next year or so. “However, a whole percent increase in the next year would be unlikely,” he says.

In terms of prices, the greatest challenges with the higher rates seem to be with entry-level prices, making it more difficult for first-time homebuyers to qualify. As a result, according to Haynie, with mortgage rates remaining a bit higher, there may be some softening of home prices at the lower end, or at least a slowing of the increase in prices. However, he sees a reasonable amount of inventory in the next bracket up.

Another strength in the market is that community banks that do construction lending are seeing strong business. “This is also a good sign,” Haynie says.
Historically, community banks have tended to have a conservative strategy when it comes to mortgage lending. “Community banks tend not to go overboard with lending, including mortgage lending,” says Haynie. They look carefully at appraisals, and they don’t chase every deal. “When it comes to mortgage lending, community banks should really just continue to do more of the same.”

Tried-and-true strategies

One community bank that continues to rely on tried-and-true mortgage lending strategies is $500 million-asset The Peoples Bank in Coldwater, Ohio. “With so many millennials entering the workforce and typically generating more income than their predecessors, I think home sales will remain strong into 2019,” says Jack Hartings, president and CEO. “If the Fed continues to raise rates and the yield curve does not invert, we will see higher mortgage rates. That will cut into home affordability, but I see that only as a minor headwind in the housing market.”

In terms of mortgage lending strategy, Hartings believes that it comes down to common-sense underwriting and putting people in homes they can afford. “Try not to hit the peak debt ratios when qualifying the borrower,” he says. “In addition, continue to monitor the appraisal thoroughly for inconsistencies in comparable property sales prices, adjustment, days on market, etc.

“Our typical customer is buying a home they plan to live in for the next 20-plus years, so short-term fluctuations in their home value are not devastating.”
Hartings believes that community banks need to follow the same formula that kept them, for the most part, afloat during the financial crisis: common-sense underwriting, fully amortizing loans, no bait-and-switch rates, and not stretching underwriting with “creative” or no-down-payment lending.

“The best thing community banks can do for their customers is counsel them on the responsibilities of buying a home and help them be prepared to meet those homeownership obligations.”
—Jack Hartings, The Peoples Bank

“The best thing community banks can do for their customers is counsel them on the responsibilities of buying a home and help them be prepared to meet those homeownership obligations,” Hartings says. “When you know your customer, doing this is instinctive. This keeps both the bank and the customer out of hot water when a property value or income decreases.”

Another bank with a successful and conservative strategy is $320 million-asset First Option Bank in Osawatomie, Kan. “We don’t bet either way on which way prices are going to go, and we have remained out of the spec construction lending [arena] since the 2007 bust,” says Blake Heid, president and CEO. “We still do custom construction projects, but they all qualify and have reserves like they are supposed to.”

Heid believes that if community banks are in the real estate lending business, they should have a nice portfolio of real estate loans in various markets, in many communities, in different neighborhoods, on different amortizations and at various stages of their life cycle. “I don’t think there is anything you can do to hedge real estate prices,” he says. “If you stay consistent with your underwriting and follow appropriate guidelines, you should keep your losses in line regardless of prices of homes. People really do their best to pay their loans.”

Downturn in the cards?

W.R. Robbins, CEO of $800 million-asset Farmers Bank & Trust in Great Bend, Kan., is one community bank leader who feels there could be an eventual downturn in the market. He’s therefore following an even more conservative strategy. “We’re trying to be more conservative in residential mortgage lending. While still meeting our customer needs, we are working hard to require additional cash down or obtaining private mortgage insurance,” Robbins says.

He adds: “With 2019 around the corner, we are being cautious with underwriting and loan pricing. There are many interest rate models that indicated they could decrease during the third quarter of 2019. We have to listen to the economists but also strive to meet the demands of the banking communities we serve.”

William Atkinson is a writer in Illinois.