Millennial Mortgages – Can AI deliver a human touch to home lending?

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Every year $25 Trillion in new mortgages are issued. Mortgage is perhaps the biggest investment decision consumers make in their lifetime. However, the mortgage process is inefficient, highly intermediated with many pain points and remained has so without too many disruptions for decades.  Low interest rates and squeezed margins define the current state of the incumbent mortgage lenders, who can hardly think of a better way of doing business. Two startups Habito in the UK and Better in the US are using AI to add efficiencies to different parts of the Mortgage processes.

Habito is a UK based startup that is the first to use Chatbots to address the Mortgage advisory/broker space. Habito’s Digital Mortgage Advisor (DMA) looks up details of a customer’s financial life (e.g. employment, salary and personal life plans) with real-time market mortgage rates to calculate an indicative monthly payment. The DMA explains the impact the customer’s decision will have on the mortgage numbers as a traditional mortgage broker would, but in a fraction of the time (average 10 minutes). Habito is founded by Daniel Hegarty, who was Wonga’s head of Product, and is backed by angels including Transferwise CEO Taavet Hinrikus, Funding Circle’s founder Samir Desai and Yuri Milner.

Better, a startup based out of New York led by Vishal Garg, have managed to address the broader mortgage process, right from advising them on the right mortgage option, using AI ofcourse, to funding the mortgage. They have hired the CTO of Spotify to help them with AI capabilities that would personalise the mortgages to the customer’s financial profile. Since their launch in 2014 they have managed to fund over $500 Million in Loans. Earlier this year Better raised $15 Million from Kleiner Penkins and Goldman Sachs that valued them at $220 Million.

"I'm sorry if some of the 'affordability' questions we're require to ask may seem inappropriate."

A JD Power survey earlier this year, found that 62 per cent of people under 35 who bought a home this year said they would use a mobile app for a mortgage application, if their lender provided it. The home buying process, which is meant to be a happy phase in life, often turns out to be traumatic, filled with uncertainties. We have seen some startup activity in the real estate/proptech space (Purple bricks in the UK), real estate transaction management (on Blockchain), and real estate valuations using IoT data monitoring. However, the major pain points in the mortgage process have been broadly overlooked.

Mortgage Pain

Better and Habito have managed to look at the Mortgage lending process and improved it through clever technology, processes and business model changes. Let’s look at a few example pain points within the traditional mortgage process.

Inefficiency #1: Customers looking to buy a property typically need to factor in a few weeks to get a letter of verification (called Agreement in Principle in the UK). This letter states how much the customer can borrow, at what rates and what the monthly payments would be. So if by chance a customer found a property that he would like to move quick on, he would generally be disadvantaged. Cash only customers always have an advantage in real estate transactions.

The Millenial Way: Better have approached this as a two stage process. The first stage where they get information from the customer, and tell them what products are available for them. This is done by proprietory AI algorithms similar to Spotify’s algorithms to provide personalized music. At the end of this process customers would have a verified pre-approval letter reviewed by an underwriter. Better claim this letter would be available in 24 hours from the time the customer has made the request. The second stage kicks in after the customer has found a property, where the mortgage economics revolves around the property.

Inefficiency #2: The process of choosing the lender involves a lot of variables, however, customers generally go with the lowest overall cost of the mortgage (including various fees, upfront monies and Monthly EMIs) for the best period. They often lack visibility and guidance on what would be better for them, a larger upfront deposit or a larger monthly EMI.

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The Millenial way: Better provide complete transparency in terms of what is good for a particular customer – a higher upfront payment, or higher monthly EMI. This would depend on how long the customer intends to live in the property chosen, which in turn would decide if the break even would occur within that period.

Habito takes an unbiased and a personalised approach to choosing mortgages depending on the customers profile. The AI behind it ensures that customers are at the heart of the mortgage recommendations.

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Inefficiency #3: Mortgages often come with various costs attached to them, which is primarily because there is a person behind the scene trying to sell and close the deal for the lender, and this person needs to get paid. Also, mortgage brokers often sell products that get them better commissions

The Millenial Way: Better mortgage has no hidden costs, and it is completely free of admin charges. Better employs staff who will unblock the mortgage process, and help people through it, rather than sales staff to close deals. Their loan officers never get paid commissions. That’s a much needed change.

Habito charges equivalent fees across all mortgages as AI algorithms don’t have vested interest (yet). This ensures the customer gets the best product suited for his needs, everytime.

Inefficiency #4: Mortgage lenders offer a rate, but very often during or just before the process of the application increase the rates. I know a few friends and colleagues affected by this completely unacceptable approach by Mortgage lenders.

The Millenial Way: Better mortgages offer full transparency throughout the mortgage process. The use of technology to hold all mortgage information centrally, and loan officers who are not incentivised to mis-sell products helps too.

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As a Better customer, you can stay on the mortgage process 24 X 7, all 365 days. If a customer wanted to progress quickly on a property over a weekend (day or night), unlike high street banks, they would be able to get the required approval letters. That truly feels like a Millenial way to Mortgages!!

AI is no human

These are some interesting stories of efficiencies being added to the Mortgage process and business model, through intelligent AI algorithms. However, I firmly believe AI cannot completely replace a human on a Mortgage or an Insurance conversation. If I were going through a home buying process, or an insurance claim for a car accident, I prefer to talk to a human who understands the emotions of the process and treats it with empathy. However, I believe AI can add efficiencies, make the process unbiased, and provide personalised insights through thousands of data points that the human brain can’t cope with. The human in this process will just need to be – humane.

The US mortgage industry is $8.4 Trillion in size, and the top four fintech firms offering mortgages do just about $1 Billion in funding. There is still a long way for these firms to go, but a ground up approach to mortgages, cool technologies, and of course a human touch throughout the process can definitely proivde a happier home buying experience for customers.

Arunkumar Krishnakumar is a Fintech thought-leader and an investor. 

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The $14 trillion mortgage market disruption game is about to start

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At $14 trillion (total debt outstanding, USA only), the mortgage market is about 14x bigger than either Auto Loans or Student Loans (each about $1 trillion). Yet the mortgage market has so far remained relatively immune to disruption and has been a mainstay of bank profits. We believe this is about to change. 

 In this post we look at the players in the market and the forces driving disruption, plus one wildcard disrupter. Our analysis mostly focusses on USA, but we touch on other markets such as China.

Mortgage players

We see 6 types of player – Banks, Altfi/MarketPlace Lenders, Technology Enablers, GAFA & BAT, Quicken, StartUps.

Banks

Wells Fargo dominates, with JP Morgan Chase, Bank of America and US Bank all having major market share.  This is changing as big banks flee the market after all the troubles caused by the Sub Prime mortgage blowup in 2007/8. Look at this chart from the Mortgage Bankers Association:

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Between 2007 and 2014 the commercial banks share went from 74% to 52%. Out of that 22% drop, 2% went to Credit Unions (i.e. small banks), but 20% went to Non-Banks.

TL:DR, this market is opening up and big banks losing 22% is a disaster for them.

Altfi and MarketPlace Lenders

So far, this has been the dog that did not bark yet story. SOFI has been the most aggressive about moving into adjacent lending segments, but they have not yet been big players in mortgages. Lending Club recently moved into Auto Loans but has so far steered clear of Mortgage Lending. So the 20% that went to Non-Banks came from somewhere else.

Technology Enablers

National Mortgage News has a great article on what it took to make a fully paperless mortgage transaction. The technology enabler, DocMagic, is worth keeping an eye on and there will be other tech enablers. Mortgage processing going paperless is one of the key drivers for disruption that we look at below. 

GAFA and BAT

GAFA (Google Amazon Facebook Apple) and BAT (Baidu Alibaba TenCent) like massive markets that are ripe for disruption. Mortgage lending qualifies. So what are they up to?

So far, this is another dog that did not bark yet story. However, anybody entering this market must figure out how they will play with them when they do enter the market.

  • Amazon. This is not an adjacent market for them and there are no signs yet, but given the famous Bezos line – “your fat margin is my opportunity” – it must be on their radar screen.
  • Facebook. They are a natural for P2P Mortgage Lending (see below) but no sign of them entering the market yet.
  • Apple. “Siri, get me a mortgage” is still in the realm of science fiction.
  • BAT are all in the Finance business, but with no clear focus on mortgages.

In China, the one to watch in mortgage lending is Pinganfang. This is a real estate e-commerce platform, helping home buyers to get mortgages. It is a collaboration between PingAn (a financial holding company with a historical focus on Insurance) with a major property developer in China called Shum Yip Group. They pitch it as “Real Estate + Internet + Financing”.

Quicken

Quicken Loans is already a major player in mortgage lending and as a tech-centric player we expect them to benefit a lot from the coming disruption. This is a leading tool that the family uses to plan and manage finances, so it is natural for consumers and business owners to turn to them when the biggest financial decision that a family makes comes up, it is natural to turn to Quicken.

StartUps

This thread on Fintech Genome has some interesting ventures and a great discussion of the issues. Please go there to comment.

Its more about Fin than Tech

Big players such as GAFA may be waiting for clarity on three things all of which have some political risk (aka “what will Trump do”):

  • Interest rate policy
  • What happens to Fannie & Freddy?
  • Bank deregulation

Three Forces driving Disruption

  • Going Paperless. This enablers new entrants without a lot of back office processing capability. Look at the company doing the mortgage in theNational Mortgage News has a great article on what it took to make a fully paperless mortgage transaction. They are small. Going paperless will eradicate one of the benefits of scale. New entrants can come in and Community Banks can compete better with Big Banks.
  • Big Banks exiting after SubPrime blow up and nervous of more big fines. This is where Bank deregulation could reverse the trend.
  • Consumer rejection of brand loyalty to big banks. Even if Big Banks jump back in if they don’t fear regulation so much, there is a whole generation of consumers who have never had a close relationship with a bank and if they think of them at all they have a negative brand connotation.

The P2P disrupter

In May 2000, a venture called CircleLending was founded and went through the normal VC rounds, but failed as a business after briefly being branded Virgin Money. It was a classic “idea ahead of its time”. The idea was simply to service loans between friends and family. This is fundamentally different from loans between strangers, because a relationship of trust exists. I financed my first property this way and it was a good result for me and for my sister as the investor. It is a fundamentally disruptive idea, because no external lender is involved. The intermediary only handles the back office part. The idea was reborn in 2010, when a former Virgin Money US employee launched a new venture, National Family Mortgage. The average interest rate is 2.96% as I write and they take zero points. The numbers loaned to date are a drop in the proverbial bucket, but this has the potential to scale fast.

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If you want to comment, please go to this thread on Fintech Genome.

The Digital Mortgage Market II: Software, Platforms, Analytics, Apps, Chatbots, and Bitcoin payments!

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Kevin Simback and Josie Lee seeded the list of US companies using technology in the broad Digital Mortgage Market – MortgageTech. I keep the conversation categorization and add on a few names.

1 – Mortgage Enterprise Solutions – this includes offering Loan origination system (LOS) providers, marketing/lead gen/application/underwriting/fulfillment/closing platforms, servicing platforms and other component solutions targeted primarily towards originators, issuers and servicers.

Blend Labs, Cloudvirga, Preclose, Roostify, RealKey, and Ellie Mae

2 – Tech-Enabled Mortgage Lenders – companies who are in the business of originating mortgages directly to consumers. Also any form of tech-enabled brokerages, as long as the company has responsibility for taking the customer’s application all the way through underwriting and funding decision.

Better Mortgage, Lenda, LendingHome, Sindeo, Clara

In this broad category, Quicken/Rocket is the old time disruptor in the space that continues to innovate. Rocket is their new digital Launchpad already in the App store. However, they aren’t using any alternative data for credit scoring and approval. Sofi, on the other hand is using a different approach to this process for the approval of home loans. Bank of America, BoFa, is window dressing their processes by adverysiing a mobile mortgage approval process in this video. Along the same lines, an crossing over to Europe, Rabobank launched an Online mobile mortgage advice via video chat, In partnership with 24sessions, whose motto is to technology for online advice. In Germany, Interhyp, is already the best Mortgage provider for close to 10yrs. This is the fintech that ING has been operating successfully and covers more than 400 German lenders.

3 – Mortgage Data and Analytics Providers – companies aggregating and/or supplying data to mortgage originators, issuers, investors or servicers.

CE Anlytics, Cignifi, Loanlogix, Scorelogix, Nomis Solutions

I add four additional, more alternative startups that will enrich the conversation since they are worth monitoring.

Income& (Income And) that is offering investors access to PRIMO investing. In plain words, an alternative fixed income investment into to Prime rated individual mortgages. This is P2P investing focused on prime mortgages. The company launched early 2016, so very early stage.

Coinshark.io, is an app focused in the P2P lending space. They offer the ability to pay your loan with Bitcoin. Housing payments often are a large part of family budgets and for those compensated in bitcoin, this is app is useful and at the same, is storing all the relevant data.

Freedom Mortgage, an incumbent mortgage lender in the US, that is independent and privately held, has launched through a subsidiary BigFreedom, which is an App using Chatbot technology (watch a demo here) and aspiring to become an true online lender, the Uber of lending as they claim on AngelList.

Jungo is the mortgage app from Salesforce. But it is also the name of a Dutch startup (now over to Europe) that is looking to disrupt the mortgage market through crowd funding. They recently got approval from AMF to operate the P2P funding of mortgages form the crowd. In Holland there are already SamenInGeld and MetElkaarhypotheek of Obvion operating.

The conversation will continue on the Fintech Genome. The list is a starter; the challenges of the mortgage market are another broad topic that the community has started touching upon.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge Network.  Efi Pylarinou is a Digital Wealth Management thought leader.

Marketplace Lending depends on savers moving on from bank deposits

Deposits

The Fintech is dead meme is now in full flood. Authoritative sources such as this Deloitte report (with sensationalist headline from Business Insider) add credibility to this meme.  This feels like the Internet is dead consensus in 2002. At the time I vividly recall the relief with which media companies and retailers greeted the demise of the Internet – “phew, pleased that craziness is all over and we can get back to business as usual”.

This time is NOT different.

These boom and gloom cycles are the norm. 4 of our 2016 Predictions in December have already come to pass (updates in italics):

#   3. Momentum Capital (short term hype chasing) into Fintech will slow down but Innovation Capital (funding long term value creation) will increase because the reality of the opportunity is not impacted by the hype cycle. The crash was obvious but we are also seeing new VC rounds getting done and Lending Club stock bouncing off the bottom.

#  5. Consolidation will start in Lending Marketplaces. There will be a fierce battle for a winner takes most network effects market (similar to what we saw in ride sharing in 2015). This is happening now. It looks like Lending Club and Prosper will survive and thrive unless the whole model is flawed (which we do not believe for reasons explained below).

#   6. The strange inversion we saw in 2015, when private companies were valued higher (on paper at least) than public companies, will end in 2016.The headlines will refer to Unicorpses. This is happening but is not yet over. It means private valuations have further to fall and public valuations (of a few winners) will rise.

#     9. Calls for regulating Fintech startups more intensely will follow at least one high profile blow up. The Lending Club blow up qualifies and has led for calls for more regulation.

3 Predictions for 2016 still to come 

(Apart from predictions relating to Bitcoin and XBRL which do not impact this story)

#   7. Analysts covering Banks will start referencing Fintech disruption when referring to a drop in profits at a major bank. This will happen if Banks start losing depositors (see later).

# 8. Moves by Big Tech and Big Retail into Financial Services will eclipse moves by Fintech startups and will worry bankers a lot more. This could come from Western Big Tech (Google has big ambitions & can play a major role in origination and comparison) or from Chinese Big Tech (Alibaba has already demonstrated big ambitions in Finance)

# 10. The Great Convergence between Banks and Fintechs commences, as both get judged on the same metrics by consumers,regulators and investors. Growth, gross margin, Customer Acquisition Cost, Churn, Lifetime Value are metrics you can use to evaluate Banks or Fintechs or Tech Enabled Financial Institutions (aka grown up Fintechs or efficient digital banks).

 

The Mortgage Elephant in the room

Mortgages dwarf all other lending at over $1 trillion per year in the US alone. No wonder Wall Street chose this market for securitisation. No wonder that this market could blow up the global economy when it went wrong in 2008.

As long as lenders don’t do anything silly with loan to value ratios, it is a great business. For consumers it is all about the best % rate. Making the process easier (classic Fintech advantage) is minor compared to best rate. With good collateral (if loan to value ratios stay sane) banks and AltFI can offer low rates. Which means that lowest cost of capital wins. Which means that Banks will win. It is simple. If you stacked up these two players, which will win:

  • Player # 1 has lower processing costs.
  • Player # 2 has lower cost of capital.

That’s right Player # 2 (ie banks) win that race.

Game over?

Not quite. This is why the headline focusses on deposits.

Would Sir like some NIRP?

It has not escaped the attention of some savvy folks like Warren Buffet that paying a Bank to keep your cash is pretty weird. As Berkshire Hathaway has $63 billion in cash reserves, what Mr. Buffet decides to do with the cash has some ramifications. Even if we don’t stay long in the strange world of NIRP, investors are looking for better than zero or close to zero interest rates. So if lenders can find good risk adjusted returns on Lending Marketplaces they will seize that opportunity. If the borrowers are willing to put up their house as collateral, the risk adjusted return looks a lot better than bank deposits.

Lending Marketplaces have two sides. If Lenders move to these markets looking for better risk adjusted returns than bank deposits, then Lending Marketplaces will thrive (and Banks will suffer).

Disclosure: the author was lucky enough to buy Lending Club stock at $3.51 on May 17 (after writing this post).

Daily Fintech Advisers provide strategic consulting to organizations with business and investment interests in Fintech. Bernard Lunn is a Fintech thought-leader.