Much of the innovation in the U.S. mortgage industry over the last several decades has been aimed at streamlining the origination process — and, on the darker side, getting creative about loan approvals. With the long-term economic outlook improving, it is time to begin thinking about a post-crisis industry that includes a healthy dose of innovation in banks' menu of mortgage products. For inspiration, American banks need only look to the Australian banking industry.
Australian banks treat mortgages as relationship products, offering a range of customer-friendly options that encourage homeowners to use their mortgages both as a loan and as a savings and investment vehicle. Banks encourage customers to make prepayments on their mortgages without any penalty. Once customers are ahead of scheduled payments, they can dip into mortgage "cash" — in other words, transfer any extra cash they've built up from prepayments back into their bank accounts. Customers tapping into their mortgage payments must withdraw a certain minimum amount of money, and some banks charge modest fees for this service. But overall, this offering helps customers gain flexibility while lowering the risk that their mortgage payments will leave them with too little cash on hand for other uses.
Australian banks also use their mortgage products to reward positive customer behavior. With repayment holidays, customers who are ahead of a loan's payment schedule can take a break from mortgage payments to help with short-term cash-flow challenges. Repayment holidays have become particularly popular around vacation times and holidays. In the U.S., by contrast, most mortgages have contracted repayment dates that stay the same regardless of whether the customer is ahead of schedule.
Banks down under also encourage saving practices — and build customer loyalty — by subtracting customers' deposit balances from their net loan balance when calculating mortgage interest. (Customers who use this service waive interest on their deposit accounts.) This feature incentivizes customers to do their primary banking with their mortgage lender.
Portable loans are another Australian mortgage option leading to greater customer retention. Popular with frequent movers, the product allows customers to transfer an existing mortgage credit balance to another property without completely restarting an origination-through-closing process. Banks charge fees to update collateral, but customers often come out ahead on the transaction while the bank hangs onto a highly valuable customer.
These options may have helped Australia achieve its admirably low default rate. Just 1% of Australian mortgages were non-performing in 2010, compared to 9% in the U.S., according to a September 2010 report from the Research Institute for Housing America. Of course, a number of factors contributed to the difference between the U.S. and Australia — including the size of the U.S. housing bubble. But it stands to reason that Australia's mortgage credit performance in the aftermath of the housing crisis may have benefited from the fact that Australian customers are able to modify their payments in order to cope with changes in cash flows.
There are certainly differences in the mortgage environments in the U.S. and Australia, such as the ratio of adjustable-rate mortgages to versus fixed-term loans, the amount of loans normally retained on bank balance sheets versus loans shifted to securitization, and the relatively lower rate risk of Australian banks. But the two countries are similar enough that U.S. banks could reverse engineer at least some of these Australian product designs.
While demand for mortgages in the U.S. is relatively sluggish at the moment, the continued economic recovery makes it likely that more consumers will eventually consider mortgages as part of a planned wealth progression. Now is the perfect time for U.S. banks to move toward true relationship banking — with an assist from their friends down under. Innovative banks and disruptors may yet be able to redefine mortgages and recast the mortgage landscape in the U.S.
Scott Mullen is a Ph.D. and principal with consulting firm North Highland and specializes in financial services. He is a former national bank executive with over 25 years of industry banking experience.