Investor Insights: The Mortgage Firehose, A Catalyst for FinTech

Investor Insights is an Ocrolus guest blog series featuring prominent voices from the investment community. The series highlights industry trends, funding culture, and observations about the fintech space. 

Today’s author, Matt Levinson, is a Principal on the investment team at FinTech Collective. Matt leads the firm’s thesis and investing across fintech infrastructure, banking, payments, and real estate. Matt’s portfolio companies include Ocrolus, Plaid, Quovo, MoneyLion, Flutterwave, Vestwell, and Extend, among others. Prior to joining FinTech Collective, Matt co-founded NYC-based startup Aerobo, a venture-capital backed provider of drone services. Previously, Matt worked in private equity at AEA Investors, where he helped the firm deploy nearly $500m into middle-market buyout transactions.

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In 2021, we can track a friend’s Uber ride in real time and order just about anything online with a few clicks. In this context, customers are becoming less tolerant of a painful, 40 day process to finance their most significant personal and financial asset. Why is mortgage stuck in the past, and how might startups bring us to the future?

Before answering this question, it’s important to understand the historic demand shining a light on the issue. Mortgage lenders in the U.S. originated approximately $4.4 trillion in 2020 alone – almost double the $2.4 trillion originated in 2019.

First Lien Mortgage Origination

Faced with a firehose of demand, mortgage lenders are throwing bodies at the problems. They increased staff by 40% in August (year-over-year).  There are now more than 100,000 mortgage brokers in the U.S. for the first time since 2007.

The Firehose Explained

What is driving the growth of this market? There are three notable tailwinds.

The first trend is governments’ use of monetary policy to combat the economic impact of COVID.  In the U.S., the Fed “printed” nearly 30% of all dollars in existence in 2020 alone, and guided that rates will remain near zero until at least 2023.  Moreover, the Fed acquired over $1.4 trillion of mortgage-backed securities in 2020, significantly eclipsing any historical period.

As a result, the average 30-year mortgage rate fell consistently throughout the year, generating a significant refi boom.

US Mortgage Rate Drop Trend Chart

In Denmark, where rates have been negative for 9 years, you can now take out a 20-year mortgage at 0% interest.  Yes – you get free money, with 20 years of life risk at no cost.

The wave of refinancings may continue for some time.  As of December 2020, about 40 million borrowers could save $100+ per month by refinancing.  Lenders are currently only capable of processing up to one million loans per month, implying a 3 to 4 year potential backlog.  This provides a clear incentive for lenders to double down on technology in 2021.

Second, COVID has created a secular trend towards remote work – changing people’s priorities on where and how they live. This is a tailwind that Zillow’s CEO has referred to as the “Great Reshuffling.” People are contemplating areas with lower cost of living, more favorable tax codes, and what they want in a home (e.g., an office or gym).  Early evidence of this trend is accumulating, with new home sales (and new mortgage originations) in the U.S. recently hitting a 14 year high.

Third, the millennials (the biggest generation ever) are entering their prime earning years and may buy homes en masse for the first time. This trend could slowly pick up steam over the next decade.  With the change in administration, we could also see the return of first-time home buyer tax credits – which would further drive the conversion of millennials from renters to buyers.  And prior generations empowered by a decade of asset appreciation and newfound mobility may reshuffle, driving incremental volume as well.

The FinTech Opportunity in Mortgage and Alternative Financing:  Early Innings

It’s clear we are still in the early innings of the digitization of mortgage. The average mortgage still takes 40 days to close and 80% of homeowners agree that technology should improve the process.

The opportunity to refresh the mortgage technology stack was made abundantly clear to me this summer, when I had the misfortune of refinancing with one of the largest American originators. The process took two months, and left me with anxiety around security, accuracy, and certainty throughout.

The documents required to underwrite me included:

• Two years of W2 tax forms
• Two years of tax returns (1040s)
• Last two years of K-1s
• Last two months of paystubs
• Two “year-end” paystubs
• Copy of master insurance policy
• Two months of bank statements (all pages required)
• Two months of all brokerage / wealth management account statements (all pages required)
• Two quarters of retirement account statements (e.g. 401k, IRA)
• Documented proof of 12 month on-time maintenance / HOA payments

I was asked to submit the documents via email (and PDF attachments), which were sent to a BPO for data entry. The completed file was reviewed by a human underwriter.  Delays in the process caused me to resubmit newer versions of most statements.

When it came time to close, I was asked to show up in person and sign dozens of contracts with wet ink, despite a global pandemic.

There has to be a better way, especially as the entire home-buying process is reimagined – from contactless buying and virtual tours, to iBuying and the promise of “one-click” real estate transactions. As friction is removed from buying a home, friction must be removed from obtaining the mortgage as well.

But we’re clearly not there yet. Headcount in the mortgage industry has been tightly correlated with throughput over the past 20 years – indicating little efficiency driven by tech so far.

October Historical Correlation Chart

Startups Addressing the Opportunity Today

For the reasons mentioned above, more scalable and secure infrastructure is shifting from “nice-to-have” to “must-have.” We see startups innovating across four key vectors:

1) Data infrastructure to streamline and enhance underwriting:  Collecting documents for a mortgage causes significant friction today. FinTech Collective portfolio company Ocrolus is leading the charge on classifying and digitizing financial statements, as well as validating, analyzing and enriching the data.  Ocrolus uses computer vision, OCR, and human-in-the-loop quality control to transform any image into structured digital data with over 99% accuracy and industry-leading speed.  Ocrolus also provides mortgage lending fraud detection technology, reducing fraud for some customers by 100 basis points, and partners with Sentilink for detecting synthetic identity fraud.

Documents are just one piece of the data infrastructure puzzle. Plaid (also a FinTech Collective portfolio company) is the market leader for providing direct bank account connectivity.  Alongside Plaid, startups such as Argyle, Pinwheel, Atomic, and others provide APIs to aggregate payroll data.  Similar connectivity is being built for wealth management accounts, retirement savings, and other data sources used to verify employment, income and assets.

After the data is normalized and fed through underwriting algorithms, other fintech startups are providing novel ways to enhance analytics with alternative data and machine learning. One set of startups is improving equitable decision-making and removing racial bias in the underwriting process.

2) Digitizing client interactions – from onboarding through appraisal, closing, and title:  Digitization is beginning to take hold throughout the customer journey.  Starting with customer onboarding, startups such as Blend and Roostify are providing modern software to lenders to holistically digitize the onboarding experience.  These companies leverage the aforementioned data infrastructure to compile an application and feed it into a bank’s loan origination system – reinventing the UX in the process.

As underwriting unfolds, lenders are more frequently relying on automated valuation modeling (AVM) to supplement, or potentially replace, the traditionally analog appraisal process. When it comes to sealing the deal, software companies such as Qualia and Spruce are then coordinating eClosing – including the contracting process, managing escrow accounts, and securing the title and arranging for title insurance.

These software companies may continue to converge or consolidate – with Blend now offering eClosing and title insurance products, as one example.

3) D2C startups gaining share with better customer experiences:  While the aforementioned startups are focused on providing tech to existing lenders, D2C startups are also looking to gain market share by streamlining mortgage.

First, non-bank fintech lenders may continue thriving.  Low rates (and cheap capital) dampen the banks’ biggest advantage:  zero cost-of-capital associated with deposits.  Rocket mortgage first established the playbook here, growing from 1.3% to 6.7% market share over the last decade as a digital-first mortgage brand.  Over the same timeframe, traditional banks market share receded from 75% to roughly 50%.  De novo lenders such as Better Mortgage have risen in this context, competing on customer experience and leveraging cloud-native technology to bring the entire process online.

Aggregators such as Simplist, Morty, Bankrate, and others are making it easier to compare rates online, and competing on their ability to facilitate faster and more accurate pre-approvals. And former Zillow execs recently created Tomo, raising a $40m Seed round on the promise of streamlining the mortgage and home-buying process for both buyers and agents.

Rather than improve mortgage, other D2C startups are arbitraging the slow mortgage process. As an example, companies such as Flyhomes and UpEquity help consumers compete with all-cash buyers. These companies front the entire purchase price of the home (or provide a guarantee to the seller) – anticipating that the buyer will get underwritten for a mortgage later in the process.

4) Startups providing alternatives to mortgage debt:   Lastly, a number of startups are beginning to provide financing alternatives to the traditional mortgage.

Easyknock (on the residential side) and Unlock (on the commercial side) are re-inventing the sale-leaseback.  This kind of transaction helps owners access the equity value in their property when they need it most, without taking on significant debt.

Figure is simplifying the process to obtain a HELOC (home equity line of credit), enabling consumers to apply online in minutes and receive the funding in a matter of days.  And companies like Unison, Point, and Noah will invest in the equity of a home – helping consumers reduce their debt, access cash, or “right size” their exposure to their largest financial asset.

Just like traditional mortgage lenders, each of these alternative financing structures relies on critical infrastructure for accurate and secure underwriting. In that sense, the same innovation that helps to reinvent mortgage could ultimately expand the market opportunity for alternative financing.

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The fintech opportunity in mortgage is truly massive, and COVID may be the catalyst that drives change.  Whether you’re a lender, loan origination system, or a consumer facing startup – next generation infrastructure, underwriting and  mortgage automation will be critical in the path to success.

If you’re an entrepreneur skating to where the puck is headed, please reach out to me or my colleagues at FinTech Collective!

Thank you so much to a number of friends and colleagues who have offered feedback along the way, including Sipho Simela, Atish Sawant, Sean Lippel, Carlos Torras, Zak Schwarzman, and Jeff Reitman.