Mortgages : The Ultimate FinTech Disruption

When people think of FinTech, they think of a few things like peer-to-peer lending, payment companies, asset management firms, or maybe even cryptocurrencies. But one of the most outdated yet burdensome costs in all of finance, spread across the widest range of people, is still overlooked. The mortgage lending process is heavily padded with fees that are remnants of a bygone age.

Enter the ATOM.  

First, we must begin with the effect of technology on short-term interest rates. The Fed Funds rate was close to zero for several years, and it is apparent that any brief increase in rates by the Federal Reserve will swiftly be reversed once markets punish the move in subsequent months. We are in an age of accelerating and exponential technological deflation, and not only will the Fed Funds rate have to be zero forever, but money-printing will be needed to offset deflation. This process has already been underway for years, and is not yet recognized as part of the long term trend of technological progress. 

A 30-year mortgage was the standard format for decades, with a variable-rate mortgage seen as risky after a borrower locks in a low rate on their 30-year mortgage. But when the Fed Funds rate was at nearly zero, the LIBOR (London Interbank Offer Rate) hovered around 0.18% or so. If you get a variable-rate mortgage, then the rate is calculated off of the LIBOR, with an additional premium levied by the lending institution. This premium is about 1.5% or more. When the LIBOR rate was over 3% not too many years ago, the lender premium was only a third of the mortgage, but now, it is 85-90% of the mortgage. So instead of paying 0.18%, the lender pays 1.7%. This huge buffer represents one of the most attractive areas for FinTech to disrupt, as what was once a secondary cost is now the overwhelmingly dominant padding, itself a remnant of a bygone age. 

When almost 90% of the interest charged in a mortgage merely represents the value that the lending institution provides, we can examine the components of this and see which of those could be replaced with a lower cost technological alternative. The lender, such as a major bank, provides a brand name, a mortgage officer to meet with face-to-face, and other such provisions. All of this is either unnecessary, or can be provided at much lower cost with the latest technologies. For example, blockchains can ensure the security aspects of the mortgage transaction are robust. Online consumer review services can provide an extra layer of reputational buttressing to any innovative new lending platform. The rationale for such a hefty mortgage markup over the underlying interest rate is just no longer there. 

If the lender premium in a mortgage falls from 85-90% down to, say, 50%, then the rate on an adjustable rate mortgage will decline to just twice the LIBOR, or about 0.4%. Even thought the Federal Reserve has recently increased the Fed Funds rate, this is very temporary, and 0% will be the Fed Funds rate for the majority of the forseeable future, just as it has been for the last 9 years. 

When this sort of ATOM-derived cost savings on interest payments percolates through the economy, it will cause a series of disruptions that will greatly reduce one of the last main consumer expenditures not yet being attacked by technology. Housing costs have risen above the inflation rate in many major cities, against the grain of technology. This is unnatural, since a home does not spontaneously renovate itself, get bigger, or otherwise increase in inherent value. On the contrary, the materials deteriorate over time, so the value should fall. Yet, home prices rise despite these structural forces, due to artificial decisions to restrict supply, lower bond yields through QE, etc. This artificial propping up of home prices masks the excessive costs in the industry, particularly in the mortgage-lending sector. As Fintech irons out the aforementioned outdated expenses in the mortgage-lending process, many fundamental assumptions about home ownership will change. 

Home ownership is a very emotional concept for many buyers (which is why there is a widespread misconception that a person 'owns' their home even while they are making mortgage payments on it, when in reality, ownership is achieved only when the mortgage is fully paid off). This emotion obscures the high costs of obsolete products and procedures that continue to reside in the mortgage industry. 

Amidst all the technological disruptions we have seen within the last generation, most people still don't understand that the central origin of most disruptions is an outdated, expensive incumbent system. But the FinTech wing of the ATOM has started the 'cracks in the dam' process against a very substantial and widely-levied cost, and this may be the disruption that brings FinTech's dividends to the masses. 

 

Comments

[fatcat]

I cannot agree with this statement “...This is unnatural, since a home does not spontaneously renovate itself, get bigger, or otherwise increase in inherent value...” . Don’t forget the most important factors for home pricing: “location, location, location”. If the neighborhood becomes trendy and developed then all the housing there increases in value. This value can be reflected in the rents that people agree to pay.
A much stronger disruption could come from self driving cars. Suddenly I can afford to live an extra half-an-hour driving distance away. Remoting and WFH is not affecting the prices much.

[fatcat]

Hi Kartik,
There are more costs to a mortgage – it is estimation and the risk of default/foreclosure, mortgage and bank agents. Legal paperwork, etc...
Securitization of the mortgage pool and selling it on the market has to be factored in too. And CMO/MBOs are not risk free. There is low but systematic risk in case the markets take a dive.
One big problem is that homes are not standard and equal. Even sales agents have no firm idea how much a house can be sold for. If only there was a way to short sale houses. That would actually bring some very interesting dynamics. Especially if a big player can borrow money close to LIBOR or some other interbank/prime rate.

[Kartik Gada]

fatcat,

Don’t forget the most important factors for home pricing: “location, location, location”. If the neighborhood becomes trendy and developed then all the housing there increases in value.

That is akin to when people thought gold would always rise in value under the assumption the supply is fixed.

Real Estate supply can always be increased, and in many cases they obstruct new construction (despite market forces demanding it), just to prop up the value of existing supply. That is just as immoral as the DeBeers cartel.

But the asset itself is a depreciating asset. Not the land, but the structure.

[A.M.]

Fascinating article.

However, I'm skeptical that reducing the price of loans would foment any loosening of the restrictions that make housing so costly in the first place. If anything, it'd would do the opposite. A lower price for loans just means people can bid up housing prices that much more.

What's needed for housing is an Uber-style solution of building a devoted popular following despite being illegal. But that's obviously much harder if not impossible to do with stationary buildings than fleeting cars that already exist. A good start would be tech billionaires simply caring about high housing prices for their employees. High housing prices and low housing supply in the Bay Area is holding back everything you write about, bit by bit.

[Kartik Gada]

A.M.

The lower interest rates will initially increase home prices, but then (just like with oil before it), the high prices create pressure for more construction, and more technological disruption in construction which then exerts even more pressure on cartelized zoning restrictions to increase supply. The Bay Area is the worst in this regard, as there is no shortage of land (see all the empty parking lots and 1-story strip malls). Everything is about artificially restricting supply.

Yes, tech companies not caring about housing costs for their employees is a surprising blind spot.

[fatcat]

There is something else that bothers me. The home renovation is very hard to automate. Yes, you can have fancy cordless power tools and advanced painting rolls. But in essence it is highly specific and labor intensive. Sometimes it is ridiculous. Like the price to install a water heater tank is comparable to the cheapest models. Same applies to kitchen and bathrooms. If only everything was standardized and modular, then renovating the bathroom would be like choosing the options for layout 236 from the factory…

[Kartik Gada]

fatcat,

That is partly true. But remember that a) there are tons of DIY videos on YouTube now, and b) Craigslist makes available lightly-used items for what is often an 80% discount.

The things that are most resistant to the ATOM are things that women require for emotional reasons. Hence, the disruption shifts higher up in the pyramid..

[M.M.]

Hey, Kartik. In a previous comment here, you wrote:

"The things that are most resistant to the ATOM are things that women require for emotional reasons. Hence, the disruption shifts higher up in the pyramid."

I would love to see more from you about this - perhaps some examples.

[Kartik Gada]

M.M.,

Well, read Imran's article, The Misandry Bubble :

http://www.singularity2050.com/the-misandry-bubble/

It is simply the most famous anti-feminist article ever written.

[Geoman]

Re - remodeling - you are exactly right - things are not very standardized, or rather they are standardized around standards that are silly, overly complicated, and time consuming.

However. Even in the staid business of home building and remodeling, the world is advancing. More and more faucets are "plug and play" connectors, that take minutes to install (I just did one last week in 15 minutes for the same faucet that took me 2 hours to do last time it failed. Looking at it - it simply had much better design than the old one, with fewer connectors and fussiness). PEX tubing, shark bite fittings. Certainly plumbing is becoming faster and easier to do.

I redid my entire kitchen with IKEA cabinets a child could assemble. Pergo style flooring is fairly easy to do masterfully with minimal tools.

Electrical has been pretty simple for a while now - but I would argue LED lights mean a lot less maintenance and more simplicity. The time I spend on a ladder fusing with bad light has dropped close to zero with LEDs.

Which leads to another point - improved building materials. I installed TREX plastic wood hybrid decking in 1999 and it still looks like a million bucks. Any other decking I would have had to strip and stain at least once, if not twice, by now. Home materials have improved enormously.

I replaced all my windows with custom vinyl windows - the custom windows cost only 10% more than off the shelf thanks to robotic manufacturing, and were delivered to my door in a couple of weeks. Pop the old out, pop the new in - a one person weekend job (admittedly it took me a few weeks - I only had time to do 1-2 windows a week).

Anyway, there has been a vast improvement in the quality, price, and ease of doing home remodeling, or so I have observed over the last 30 years or so. I certainly keep expanding the scope of projects I am willing to tackle, without necessarily expanding my tool set, or skill set.

[computer_guy524]

"The things that are most resistant to the ATOM are things that women require for emotional reasons. Hence, the disruption shifts higher up in the pyramid."

How could one profit from this?

[Kartik Gada]

cg524,

1) Make Money : Sell products that cater to this trend. '50 Shades of Grey' is a disgusting book with grammatical errors (I am told). The author (a woman) has made $300M and counting. More respectable products that cater to women are also high margin. Basically, anything that tells women what they want to hear or generates that feeling. If you want to use ATOM principles, 3D Printed jewelry is an example.

2) Reduce costs : Learn Game (see the Misandry Bubble).

[computer_guy524]

For the medical field.

https://science.slashdot.org/story/17/03/23/0220216/researchers-develop-app-that-accurately-determines-sperm-quality

[M Simon]

There is currently a design for a printed house costing $10,000 complete (electrical, plumbing, HVAC) for 400 sq ft. That is $25 per sq ft.

Think of what that will do to the value of existing houses.

And of course we are only at the beginning.

Zoning regulations are price supports for real estate incumbents.

[Kartik Gada]

M. Simon,

Yes, that would be a major disruption, and is one of the most overdue disruptions.

What if I told you that since 1980, US manufacturing productivity rose by 220% (so 1 became 3.20), while US construction productivity *fell* by 25% (so 1 became 0.75).

Corruption across zoning, organized crime, and even self-serving 'owners' (i.e. mortgageholders still making payments) all combine to block the innovation. Renters/young people don't have anywhere near the political power to be catered to in this regard.

New innovations continue to be obstructed. The disruption is still a ways away (but will be very sharp when it happens).

[M Simon]

Kartik Gada | March 15, 2017 at 11:17 PM

'50 Shades' inadvertently showed women's true nature (the desire to be dominated by a strong man). It in fact supports "Game". Despite all its defects I would not be so down on it. It is a big hole in the female narrative (armor). That it was written by a female - all the better.

BTW I first learned the rudiments of Game from my first girlfriend in '62. I had just turned 18. I have never met or read such a self aware woman since. Funny enough I was one of her plates. I cried when we broke up, but in retrospect the education was priceless.

[Jason K.]

Being pedantic; you never really own your home as you lease the land from the government through property taxes. Pedantry aside, lowering the interest rates will boost home prices, especially in high demand areas. This is because most people buy about as much house as they can afford the mortgage payment for. It is clear that there are massive distortions in the construction market. When my parents had a house built a couple years ago, they couldn’t even get a copy of the plans from the architect. The only way for them to make sure things were being done as requested was to physically be there during the construction process. There is no reason that the plans couldn’t have been imported into CAD software and be used to generate a 3D walkthrough. Talk about a lack of transparency. At this point, we probably could merge CAD with augmented reality and give construction people visual overlays of where everything should go, thus removing many coordination/implementation problems.

I think we will find median house prices remarkably resistant to technological improvements, because house size/quality is a status symbol. Additionally, as the costs of lower marginal utility goods collapse, more and more money will be poured into higher marginal utility goods; goods that produce emotional satisfaction. As emotional satisfaction is relativistic in nature (you constantly adjust to current state, thus requiring more to achieve the same effect), it is an endless treadmill to spend money on.