Fundamentals of the Ratchet Mortgage
A Ratchet Mortgage combines features of fixed-rate mortgages and ARMs to offer what is in effect a one-way ARM. It thus mimics the behavior of a rational borrower who refinances into a new fixed-rate mortgage when interest rates fall, but without any borrower initiative required and with no costs to the borrower. Because the rate adjustment is automatic, it is not contingent upon a borrower’s current credit score or any other qualification standard.
Benefits to Members
The Ratchet Mortgage is exceptionally borrower-friendly. First, it saves borrowers money by eliminating the costs of refinancing. Additionally, it spares borrowers the time and effort that they currently spend to investigate their refinancing options.
By automating the process by which a borrower obtains a lower rate, the Ratchet Mortgage will in theory optimize the rate paid over the life of the loan compared to the rate paid by borrowers who have to pull the refinancing trigger and risk doing so too early, too late or not at all. And because these rate reductions are not contingent upon a borrower’s current FICO score, the Ratchet Mortgage delivers savings to those that might otherwise be ineligible for but are in great need of refinancing.
Benefits to Lenders
The Ratchet Mortgage has benefits for lenders too. By diminishing the incentive for refinancing-related prepayments, the Ratchet Mortgage would allow a lender to more accurately project future revenue and model the balance sheet. Reduced refinancing activity would lower an institution’s reinvestment risk.
Additionally, lenders would gain the ability to better control their operating expenses, which in the current landscape can be buffeted by refinancing boom-and-bust cycles.
Qualitatively, the Ratchet Mortgage would promote stickier member relationships. Refinance retention rates are a closely guarded secret in the banking world, but are thought to be well below 30 percent. This degree of churn is expensive and wasteful. A stickier relationship, based on the mortgage, presents more cross-selling opportunities. Perhaps most importantly, products like the Ratchet Mortgage create trust that the institution is committed to the borrower’s financial well-being and not exploiting ignorance or passivity.
Ratchet Mortgages in Sync with Credit Union Values
The borrower focus implicit in the Ratchet Mortgage is very much aligned with credit unions’ mission and values. Originators with shareholder obligations might balk at weaning themselves from the higher yields generated by passive borrowers and from the non-interest income that accompanies refinancings. Credit unions, on the other hand, have the flexibility and the capital to offer a better deal to the members.
Furthermore, the cooperative structure of the credit union system would promote adoption of the Ratchet Mortgage. These mortgages are designed to be funded with instruments that similarly ratchet downward, and these could conceivably be facilitated by corporate credit unions.
The Ratchet Mortgage is an intriguing innovation that has the potential to improve efficiency and distinguish credit unions from the mortgage lending crowd.
To learn about another promising mortgage lending opportunity, join us for our upcoming webinar Manufactured Housing – an Affordable Housing Solution, the fourth quarter mortgage lending series webinar brought to you by Callahan & Associates and sponsored by Charlie Mac.
Thank you to everyone who commented on the article. Your comments were very valuable in identifying future topics related to the Ratchet Mortgageä. In the near future, we will either be releasing another article or a webinar on the subject. Until that time, we will be contacting financial establishments to work through the complexities of financing and risk management associated to the Ratchet Mortgage. More to come…
Paul Seizert, Author