Most borrowers, whether they are purchasing property or refinancing their home, focus on their mortgage rate and loan terms rather than the type of lender they choose.
Yet the landscape of the lending market has shifted dramatically over the past few years from domination by big banks to a market where more loans are made by non-banks -- financial institutions that only make loans and do not offer deposit accounts such as a savings account or checking account.
"For consumers, it doesn't really matter whether you get your loan through a bank or a non-bank, although in some ways non-banks are a little more nimble and can offer more loan products," said Paul Noring, a managing director of the financial-risk-management practice of Navigant Consulting in Washington, D.C. "The impact is bigger on the housing market overall, because without the non-banks we would be even further behind where we should be in terms of the number of transactions."
In 2011, 50 percent of all new mortgage money was loaned by the three biggest banks in the United States: JPMorgan Chase, Bank of America and Wells Fargo. But by September 2016, the share of loans by these three big banks dropped to 21 percent.
At the same time, six of the top 10 largest lenders by volume were non-banks, such as Quicken Loans, loanDepot and PHH Mortgage, compared with just two of the top 10 in 2011.
Before the financial crisis, mortgages were the last thing a consumer would default on, Noring said.
"That flipped in 2009, when people started defaulting on their mortgages first," he said. "That was a tsunami for everyone in the mortgage business, and we're still seeing the fallout. Lenders were not prepared to deal with it and didn't do a great job, plus new rules were coming out that they needed to follow."
The withdrawal of banks from the mortgage business is the result of the fundamental shift in regulations that took place in response to the housing crisis, said Meg Burns, managing director of the Collingwood Group, an adviser for financial services companies in D.C.
"The regulatory atmosphere changed from a risk-management regime to a zero-tolerance and 100-percent-compliance regime," Burns said. "Not only were new regulations implemented, but new regulators like the Consumer Financial Protection Bureau were created. At the same time, the CFPB and other agencies became more assertive in their enforcement practices."
Burns said that stepped-up regulations from the CFPB include prescriptive rules that pinpoint exactly how lenders are to make loan decisions.
"The intent should be to broadly make sure borrowers can repay their loans and sustain homeownership instead of this narrow approach," Burns said. "In the face of stiff penalties and aggressive scrutiny, banks were left with a tremendous uncertainty and risk that made it hard to keep lending."
Jeffrey Taylor, managing partner of Digital Risk, a provider of mortgage-processing services and risk analytics in Maitland, Florida, said that while the post-crisis regulations were well-intentioned, the result was to make banks more cautious.
"Now banks only approve 'perfect' loans, not 'good-enough' loans," Taylor said. "This created an opportunity for non-banks that focus entirely on mortgages and are less regulated than big banks."
The cost of complying with new regulations and the risk of making mistakes drove many banks to reduce their mortgage business, said Rick Sharga, chief marketing officer of Ten-X, an online real estate marketplace in Irvine, California.
"Headline risk is another element of this, because if the media perceives you're doing something incorrectly, it can really hurt your entire business," he said.
In the initial aftermath of the housing crisis and the debacle of loan defaults, banks began to add their own overlays, which are loan-approval guidelines and fees that go beyond the requirements of Fannie Mae and Freddie Mac, said Susan Wachter, a professor of real estate and finance at the Wharton School at the University of Pennsylvania in Philadelphia.
Not only have banks reduced their mortgage loan volume, but the entire private market of investors in mortgages disappeared in 2007 and 2008 and, unlike other financial markets, has yet to come back, Wachter said.
"The aftermath of the crisis was lots of litigation and a decline in trust across the board," Wachter said.
Banks were forced to pay fines and to take back loans that were considered flawed. At the same time, they were required to meet stress tests and have more capital on their books in case they have to handle more defaults, Wachter said.
"Non-banks don't have to have capital, which could mean that taxpayers are more exposed than in 2009 if numerous defaults take place among loans made by non-banks," Wachter said.
Noring said that non-banks were more lightly regulated in the initial aftermath of the housing crisis, although in the past two years, regulators have stepped up their scrutiny of these lenders.
Non-banks are regulated in every state where they are licensed to provide loans, said David Norris, chief revenue officer for loanDepot in Foothill Ranch, California.
"Prior to the financial meltdown, loan-guarantee fees charged by Fannie Mae and Freddie Mac were substantially lower for banks compared to non-banks, but as part of the financial reform, those fees are now similar for all types of lenders," Norris said. "Now banks and non-banks are competing on a level playing field, which encouraged more non-banks to increase their business."
Many large banks have reduced their FHA loan business. Burns said FHA loans were created to serve people with a riskier profile, but she said the recent zero-tolerance policy of the Justice Department has undermined this loan program.
"Lenders were supposed to use good judgment on FHA loan approvals, such as looking at the continuity and stability of the borrower's income," Burns said. "The DOJ has used the False Claims Act to target banks in particular to fine them for defects in loan files. But a 'perfect' loan is pretty much impossible, particularly for borrowers applying for FHA loans."
FHA loans appeal to first-time buyers and lower-income borrowers, who are perceived to be more likely to default on a loan, Norris said. He said non-banks are originating more FHA loans to make up for the lack of banks offering the loans.
Many banks now limit their loans to conventional 30-year fixed-rate loans for borrowers who neatly fit into the approval box, said Sharga of Ten-X.
"Banks are also approving jumbo loans for high-net-worth individuals that they keep as portfolio loans," Sharga said. "They are offering these loans so they can sell other banking services to those customers."
During the last housing boom, many non-bank lenders targeted subprime borrowers, he said.
"This time around, the non-bank lenders are not being reckless," Sharga said. "Some offer loans to borrowers with lower FICO scores, but they are still not making risky loans. Consumers are benefiting from non-banks because they offer more opportunities to borrowers who are not perfect."
On the negative side, though, Sharga said that competition from non-banks has contributed to the closing of many community banks, which particularly hurts communities that are geographically underserved.
The entire ecosystem of the mortgage markets is fragile, said Burns, which has a chilling effect on the economy.
"The lack of access to credit not only hurts consumers, but it hurts builders and therefore contributes to the lack of affordable housing," Burns said. "That, in turn, has an impact on the broader economy, because housing construction impacts a lot of segments such as banking, construction workers, home-improvement businesses and more."
The pullback in lending from banks contributes to the overall decline in homeownership, said Burns, because people with a slightly risky credit profile are underserved.
"The expansion of non-banks in response is a good thing, but we're still missing a million or more homeowners, in part because many millennials are still not able to get credit through traditional means," Wachter said. "For good or bad, consumers with marginal credit scores and unverifiable income are out of the market now."
Rather than decide on a bank or non-bank, many borrowers focus primarily on the price of their loan or opt for a lender that provides them with other financial services or one recommended by a real estate company or builder they are using for a purchase. According to the J.D. Power 2016 U.S. Primary Mortgage Origination Satisfaction Study, 27 percent of first-time buyers regret their choice of a lender and 21 percent of all borrowers regret their choice. The most common reasons for dissatisfaction include lack of communication, unmet promises or feeling pressured to choose a particular loan. But choosing one type of lender over another is no guarantee of satisfaction. The top 10 most highly rated mortgage providers in the survey are evenly split between banks and non-banks.
Digital Risk's Taylor said banks and non-banks are aware that customers who don't feel as if they are well-served will find another provider, which is why so many financial institutions are investing heavily in technology.
"It's a race to improve the customer experience," he said. "Borrowers realize that there's not a lot of difference between loan providers on pricing, so they focus on the ease of the loan process and the service they receive."
Taylor said there are generational differences in the way consumers approach borrowing money.
"Generation Xers and baby boomers have more loyalty to their financial institutions and tend to look first for a credit card, a car loan or a mortgage to their bank," he said. "Millennials don't feel the same way and prefer to start with an internet search for their best mortgage options."
Rising interest rates and anticipated deregulation under the Trump administration could change the mortgage-lending business again and impact the volume of loans.
"We're likely to see more banks come back into the mortgage market as interest rates rise, because there's more profit to be made," Wachter said. "But demand will be down because fewer people will refinance and because affordability issues will mean that first-time buyers are still missing from the market."
Sharga said that rising rates increase profitability but also reduce refinancing, which forces lenders to compete harder for purchase-loan business, so even borrowers with a few minor issues with their loan application may qualify for a loan.
"Higher interest rates will cause funding costs to rise for non-banks, since they have to borrow money from capital markets to make their loans," said Navigant Consulting's Noring. "That could mean a rebalancing among lenders because banks fund their loans with deposits."
Burns, however, thinks addressing regulatory issues will have a bigger impact on the lending atmosphere than rising rates.
"The mortgage industry is overregulated now, so the goal should be to align important safeguards and yet get more investors and lenders back into the market," Taylor said. "I expect we'll see some right-setting of regulations so that different products can come into the mortgage market."
In particular, Taylor anticipates the use of different metrics to evaluate borrowers rather than focusing tightly on FICO scores as lenders do now. "There are already opportunities to make smart decisions based on other data, such as Fannie Mae's Day 1 Certainty program that uses independent tools to validate a borrower's income, assets and employment and make it simpler and faster for lenders to approve loans," Taylor said. "The ultimate winner will be customers, because the more clarity a lender has on what it takes to get a loan, the less risk the lender has to take."
Both bank and non-bank lenders are impacted by regulations and guidelines from Fannie Mae and Freddie Mac.
"If the Trump administration is successful in relaxing regulations, then the headwinds lenders face could be slowing down," Sharga said. "That would be good for consumers and for the housing market, as long as it doesn't lead to the laxity and craziness of the previous housing boom."