Homeowners who didn't refinance their mortgages when interest rates were below 4% may be out of luck for quite a while.
Banks had been processing big batches of refis earlier this year when the average rate fell below 3.6%. But they'll be writing fewer home loans now as rates above 4% choke off the refi business.
Quarterly results from the nation's four major banks last week showed that refis are slowing markedly, pressing banks to focus more on borrowers who want to buy homes, a lukewarm market.
"The refinance opportunity seems to have come and gone," said John Shrewsberry, chief financial officer at No. 1 mortgage lender Wells Fargo & Co.
Since the Federal Reserve took steps during the Great Recession in 2008 to lower long-term rates, small rate variations have sent the mortgage market gyrating as waves of borrowers took advantage of historically cheap financing.
In the first six months of 2013, for instance, when mortgage rates averaged around 3.5%, lenders wrote $1.1 trillion worth of home loans — 70% of them refinancings. As average rates edged above 4%, it took lenders a year to write loans worth that much, and refis were less than half the total, according to the Mortgage Bankers Assn. trade group.
After six months of lower interest rates this year, the average rate for a 30-year conventional loan has been above 4% for the last six weeks, according to mortgage finance giant Freddie Mac, and is at its highest since October.
Most experts believe that a gradual upward trend will continue as the economy improves and the Federal Reserve, as many expect, begins to raise its benchmark short-term lending rate this year.
"We expect that once the Fed starts to tighten and once the tightening leads to higher mortgage rates, refinancing originations will fall steadily through 2017," Moody's Analytics analyst Andres Carbacho-Burgos said.
"The big assumption here is that everybody who can do so has already refinanced since we are at the bottom of the mortgage rate trough, and that therefore few people will wish to do so when rates start going up," Carbacho-Burgos said.
The mortgage bankers group expects refinance loans next year to fall $172 billion, or 31%, from this year, while home-purchase loans rise only $84 billion, or about 10%. It predicts the total amount of mortgages to fall 7% to $1.3 trillion.
As mortgage lenders compete for the shrinking home loan business, some may hold down rates to gain a bigger share of the market. Although that may slow the increase in rates, it won't stop it, experts said, with the mortgage bankers group predicting a slow rise for the rest of this year.
Even so, the trade group projected that not until the second half of next year would the rate on a conventional 30-year loan climb above 5% — low by historical standards, but the highest in more than five years.
Some consumers will cope, as they have in past periods of higher rates, by turning to loans that carry easier initial terms, such as lower monthly payments for the first few years with the risk of higher payments later.
Higher rates and fewer refis mean less business for big home lenders such as Wells Fargo, JPMorgan Chase & Co. and Quicken Loans Inc. They are shifting their focus to purchase mortgages, a market where, Schrewsberry said, "things are improving, but not rapidly."
At Wells Fargo, the No. 1 mortgage lender, the second-quarter earnings report showed loan originations, or completed mortgages, were at the highest level since 2013 with a total of $62 billion, up from $49 billion in the first quarter.
But applications for home loans declined to $82 billion from $93 billion. Mortgage banking accounted for 17% of the San Francisco bank's revenue of $21.3 billion in the quarter, but Wells Fargo executives said originations would fall in the third quarter.
Demand for purchase loans, while growing, is at the mercy of the economy's slow recovery, Shrewsberry said.
"Jobs are a little better. Household formation is about the same. First-time buyers are a little stronger," he said. "If a lot more supply [of homes for sale] became available, it would help."
About two-thirds of the home loans issued last quarter were refinancings at Bank of America Corp., the fourth-largest mortgage lender. As the refis drop off, the Charlotte, N.C., bank plans to emphasize home-equity lines of credit, where it remains the top issuer, BofA Chief Financial Officer Bruce R. Thompson said.
The credit lines, a type of second mortgage, enable borrowers to convert home equity into cash. They are adjustable, often tied to the prime rate, and would rise once the Fed raises its rate.
Purchase loans typically are more profitable for lenders than refinances, which often have lower rates and fees because the borrowers have built up equity and demonstrated their ability to pay on time.
But that won't offset the decline in overall mortgage income as banks write fewer loans, said Frederick L. Cannon, director of global research at Keefe, Bruyette & Woods.
Lower volumes will mean more competition, he said, and though it could "somewhat dampen" increases in rates, it won't stop them.
For the banks, several factors will offset declines in earnings from mortgage origination fees and profits on loan sales.
Higher rates will increase the earnings from loans the banks keep as investments. And banks will benefit from what Cannon called the "macro hedge" — an improving economy that spurs rates to rise and enables the banks to make business and other types of loans.
As rates rise, Cannon expects some consumers to opt for 15-year fixed mortgages, which have lower interest rates but higher payments. Others, he said, will turn to hybrid mortgages with lower initial rates that are fixed for a set number of years before becoming adjustable.
Paul Leonard, a senior vice president in Oakland for the advocacy group Center for Responsible Lending, said his group is less worried about adjustable-rate loans than "the historically tight lending standards" at most banks, which he said were harming minority borrowers.
"Tight lending standards have had particularly serious consequences for borrowers and communities of color, who were hit hardest by the foreclosure crisis," he said.