Small-balance loans often fall to the bottom of the stack, as they are deemed less profitable by mortgage lenders. But a white paper by the Mortgage Bankers Association shows that originating this type of loan is more nuanced, especially during a market downturn.
Per the trade group's analysis, conducted with data gathered from its annual performance report and a collaboration with STRATMOR Group throughout 2021 and 2022, production costs, which typically run higher for small loan balance loans, can actually fall during a purchase market.
This may be a silver lining for the government's ongoing push to encourage more small-dollar lending, which can be a key in helping more Americans achieve homeownership, particularly in suburban and rural areas, where small balance mortgage lending is more prevalent.
The one outcome that holds true in both a refinance-dominant environment and in a purchase-dense one is that production revenue per loan usually increases as loan balances get larger, MBA's report said. Hence why mortgage companies often prefer loans that are larger.
However, the cost to produce a loan with smaller balances (averaging less than $269,255) starts to vary in a purchase market. In an origination cycle that is less fruitful, such as one seen in 2022, mortgage shops with low loan balances tended to have the lowest production costs, which minimizes net produced losses.On the other hand, lenders with the highest loan balances of over $560,000 had the highest costs and experienced the largest net production losses, MBA's research shows.
Findings from MBA and STRATMOR's Peer Group Roundtable data shows that through mortgage cycles, lenders with the highest loan balances seem to experience the "highest highs for net production profits in a strong market, but the lowest lows in weaker markets."
In 2021, a year which saw strong origination volume, total production revenues grew, with the highest loan balance group in the trade group's analysis generating $16,078 in revenues per loan, or 339 basis points, while the lowest balance group generated $9,733 per loan, or 411 basis points, according to MBA's white paper.
Meanwhile, an analysis of 2022 data revealed that there was no clear "winner" for net profits, as lenders lost on average $1,745 per loan. Interestingly, the group with the highest loan balances actually performed the worst, and production profits generally got progressively worse as average loan balances rose.
MBA's research also touches upon the correlation between servicing profits and loan size.
By relying on its annual performance report, the trade group found that servicers with the highest loan balances "experienced the highest highs for net servicing financial income in 2022 when there was low prepayment activity, but the lowest lows in 2020 when there was high prepayment activity." Once MSR-related items were removed and there was a focus more so on operating revenue and costs, servicing revenue per loan increased as loan balances increased.
The research comes after the discourse around small-dollar loans has started to resonate more, with several housing agencies launching pilots and programs to help incentivize lenders to originate more of these types of loans.
In late-October, the Department of Housing and Urban Development announced it is mulling the possibility of giving mortgage lenders and servicers financial incentives to address cost differences that hurt the availability of small loans.
The MBA has recommended for HUD to create an internal fund dedicated to issuing grants to offset the upfront cost of originating small-balance mortgage for lenders.
