What is the private-label mortgage market?
The short version is that a private-label mortgage is one that doesn't meet the lending guidelines of Fannie Mae and Freddie Mac, for one reason or another. These two agencies purchase mortgages that meet their standards for loan size, debt-to-income ratios, assets in reserve, credit scores, and more. And if a loan is eligible for purchase (and guarantee) from one of the agencies, it becomes very low risk for the lender.
On the other hand, private-label mortgages are not eligible for agency guarantees but still serve some very important purposes in the housing market. Just to name a few examples:
- In most parts of the United States, the maximum mortgage size that meets Fannie and Freddie's standards is $548,250. In high-cost markets in the continental U.S., it can be as high as $822,375. Obviously, there are many homes that far exceed these limits, which creates the need for jumbo mortgage loans.
- Self-employed borrowers often cannot meet the income documentation requirements of conforming mortgages, so mortgage companies offer private-label mortgage products to meet the needs of these borrowers.
- Conforming mortgages can certainly be used for investment properties, but borrowers must be able to qualify based on their income, which can be exceedingly difficult when a borrower has a primary residence mortgage as well. Private-label products that are based on the investment property's rental income help solve this problem.
Just like with conforming loans, financial institutions package these loans into securities (known as mortgage-backed securities, or MBS) and sell them to investors.
For the time being, the private-label mortgage market is relatively small, making up about 4% of all mortgage bonds issued in the latest quarter, according to The Wall Street Journal. But it has grown significantly, roughly quadrupling in volume since 2016.
Why is the private-label mortgage market growing so fast?
The short answer is that there is rapidly growing demand for some of the key types of mortgages that are not eligible to be sold to Fannie Mae or Freddie Mac.
For one thing, nearly 30% of Americans were self-employed in 2019, and this figure is growing rapidly. With Americans' savings rates reaching all-time highs during the COVID-19 pandemic, it's fair to assume that many buyers in this group might be pulling the trigger on homeownership.
Perhaps the biggest source of fuel to the private-label mortgage fire is rising home values. According to Zillow, the average home value in the United States is nearly 17% higher than it was a year ago, and many markets have seen year-over-year gains well in excess of 20%. In most parts of the U.S., the upper mortgage limit for eligibility to be purchased by Fannie or Freddie is $548,250 in 2021. With home values rising rapidly, demand for so-called jumbo mortgages has soared as well.
In a nutshell, there is more demand for these types of mortgages in 2021 than in previous years, and as the pandemic starts to wind down, there's more appetite for riskier loans among investors.
What it could mean to investors
From an investor's perspective, there could be two big implications. First, now that the private-label mortgage market is seeing more demand from investors, it could mean that lenders could start becoming more eager to make non-conforming loans to borrowers who need them.
Second, this could open up new (and higher-yielding) investment opportunities in the mortgage REIT industry. Because they don't have a government guarantee, private-label mortgage securities tend to have higher yields than their agency-backed counterparts, and major mortgage REITs are reporting higher demand for them.