Episode Details

Our U.S. Consumer Finance Analyst Jay Bacow and our Co-Head of Securitized Product Research Jay Bacow explain why AI can transform the way Americans shop for, manage and refinance their mortgages.

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----- Transcript -----

Jeff Adelson: Welcome to Thoughts on the Market. I'm Jeff Adelson, Morgan Stanley's U.S. Consumer Finance Analyst.

Jay Bacow: And I'm Jay Bacow, Co-Head of Securitized Products Research, also working at Morgan Stanley.

Jeff Adelson: Today, how AI could change the way Americans shop for, manage, and refinance their mortgages.

It's Monday, August 10th at 10am in New York. 

The U.S. mortgage market is worth more than $14 trillion, and its performance ultimately depends on the choices millions of homeowners make. Today, refinancing still means shopping around, comparing offers, and working through a lot of paperwork. AI could make that process much easier, especially when rates begin to fall.

Jay, you led this work on our AI mortgage blue paper. What's the main way AI could change the mortgage market, and why does the borrower matter so much?

Jay Bacow: So we think the biggest change would be borrower adoption of using AI agents to manage their personal finance. An agent on your phone could just monitor mortgage rates, compare lenders, reduce the paperwork, and make homeowners more likely to refinance when the economics work.

Let's think about what that could be. Historically, only about 30 percent of borrowers that had the ability to lower their mortgage rate by a 100 basis points did so in a given year. When a borrower went to get a mortgage quote, less than half of them asked more than one lender for a quote.

That agent could go reach out to 30 lenders, ask for a variety of different mortgages, could upload all the documents, could do this all effectively instantaneously, present the homeowner with the best option. Allow the homeowner to effectively click a button and refinance. I think this could be pretty transformative for the mortgage market.

Jeff Adelson: Now, as we think about this transformation, Jay, mortgage investors still rely heavily on past refinancing behavior trends. If AI makes borrowers more likely to refi[nance] when rates fall, how could that change the way these investors value mortgage-backed securities?

Jay Bacow: Well, we all know that past performance is not indicative of future performance, and those models are likely to understate future prepayments. If you get a faster response, it's going to make mortgages more negatively convex.

That's going to make the durations shorten. It's likely to widen mortgage spreads by about 10 basis points in our base case. And now, if that base case were to happen and we get, let's call it 100 basis point rally in the future, we think that that could cause something like a 40 percent pickup in refinance volumes versus our current expectations of what refinance volumes would look like in that 100 basis point rally.

Jeff, you cover a lot of the largest mortgage lenders. What does this mean for their business model?

Jeff Adelson: So, it's pretty straightforward. More borrowers refinancing means more loans for the industry to originate. Today, we're still sitting below what I would describe as normalized levels of originations. 

We're sitting at about $2 trillion of mortgage originations per year. As we think about normalized, we think that's somewhere in the order [of] around $2.5 trillion. So just that $600 billion alone could get us straight there. 

We tend to think about this more in our bull case, where we could see something in the order of $3