Three years ago, Heritage Federal Credit Union ($441.1M, Newburgh, IN) came up with a novel idea to help members who couldn’t benefit from refinancing their mortgages the conventional way. The product, known as Simpli-Easy Refi, lets members with smaller balances refinance first mortgages by converting them into home equity loans.
The product was a sensation with its targeted group of borrowers, those with good credit who were paying higher-than-market-value rates for mortgages that had 15 years or less before the balance was repaid. Conventional refinancing couldn’t help these borrowers because they would pay off the mortgage before they could recover the closing costs from lower interest rates alone. For these borrowers, the real incentive to refinance had to come on the front end, with bare-minimum closing costs that would make the deal worthwhile.
What makes Heritage’s product ingenious is how the credit union prunes upfront costs for borrowers while getting something of infinitesimal value in return: the opportunity to generate new real estate loans that carry substantially less interest-rate risk than 30-year mortgages at today’s historically low rates.
“Our portfolio was getting out of balance, and we didn’t want more historically low 30-year paper,” says John Phipps, chief lending officer at Heritage, which has originated more than $41 million of Simpli-Easy loans during the past two years. “Simpli-Easy allowed us to rebalance our portfolio with good quality loans that, because of our pricing, will be paid off somewhere around the 10- or 11-year mark.”
That pricing consists of fixed interest rates that are anywhere from three-eighths to half a percent higher than those for auto loans. But the real attraction is the loan’s flat $199 refinancing fee, saving members thousands of dollars in closing costs.
The strict underwriting requirements keep the loans low risk. Loan terms range between seven and 15 years, and loan-to-value ratios can’t exceed 80%, with most Simpli-Easy loans falling well below that limit. In addition, the credit union restricts maximum loan amounts to $200,000.
“Originally, we thought we would only have balances somewhere around $50,000 or $60,000, but we have some members with higher loan balances that they wanted to pay off in 10 years,” Phipps says.
Heritage suppresses costs by processing the loans through the credit union’s consumer lending rather than mortgage division, which must submit to more demanding regulations. Loans processed on the consumer side don’t require the same level of scrutiny and documentation.
“We don’t need four bank statements, six W2s, and a letter of explanation,” Phipps says. “The name says it all. It’s simply easy.”
Fewer regulatory hoops and the smaller loan balances also allow the credit union to get away with a modified appraisal and title search for most Simpli-Easy loans. Although Heritage still gets a title opinion guaranteeing the credit union’s position is secure, the loan doesn’t require title insurance or charge origination fees. As a result, the loan is not only easier but also quicker to process, up to 14 days faster than a mortgage.
A Rebalanced Portfolio
Occasionally, Heritage subsidizes the cost of a Simpli-Easy loan, particularly if it requires a full appraisal, but as a rule the $199 flat fee closely mirrors the credit union’s own costs to process the loan. Even though interest-rate margins are tight, the loans still provide a better yield than other investment opportunities, Phipps says.
The real advantage of the loans, though, has been to shift Heritage’s portfolio so it is less dependent on indirect auto loans or 30-year fixed-rate mortgages. Instead, the Simpli-Easy loans, with their medium durations, offer a sweet spot between long-term mortgages and short-term auto lending.
Although the loans are processed on the consumer lending side, they are listed as first mortgages on the quarterly call report that financial institutions are required to file with regulators. Consequently, the loans still count as first mortgages in the portfolio, but their rebalancing effect has been profound.
Heritage currently holds $32 million of Simpli-Easy loans in its portfolio because some of the balances have been paid down or paid off. Together with all other mortgages, the loans account for 33% of the total lending portfolio, up from 23% just two years ago. The most dramatic change, however, has been with the portfolio’s first mortgages, which now include more than twice as many loans maturing in 15 years or less, helping reduce Heritage’s exposure to the inevitable rise in long-term interest rates. The Simpli-Easy loans along with standard mortgages of 15 years or less constitute nearly 55% of all first mortgages in the portfolio compared to approximately 21% two years ago.
The demand for Simpli-Easy loans has leveled off for now, but Heritage has no plans to retire the product. The loans are a good fit for baby boomers, especially those 10 or 15 years away from retiring who want to pay off a mortgage so they aren’t burdened with those payments on a fixed income. Meanwhile, even though the loans have helped Heritage rebalance its portfolio, interest-rate risk continues to loom large on the horizon.
“We understand that rates are eventually going up,” Phipps says. “And we don’t want our portfolio to be heavy in 30-year paper when that happens.”