Historically, if you wanted a mortgage, your first stop was likely at a bank or a local credit union. But in recent years, you’re more likely to have borrowed from a specialized mortgage company that isn’t a bank at all, like CrossCountry Mortgage, Rocket, or loanDepot.

The Federal Reserve would like to change that. It’s considering tweaking the rules designed to incentivize banks to lend more and stay involved in mortgage servicing, the long-term administrative process of collecting and distributing payments. The goal is to introduce fresh lending competition into the frozen housing market and help lower mortgage rates.

“The capital treatment of mortgage loans and mortgage servicing assets under the U.S. standardized approach has resulted in banks reducing their participation in this important lending activity, limiting access to mortgage credit,” Michelle Bowman, the Fed vice chair of supervision, said in testimony before the Senate Banking Committee on Thursday.

“We are considering approaches to differentiate the riskiness of mortgages in ways that will benefit financial institutions of all sizes, not just the largest banks.”

In 2008, banks originated at least 60% of US mortgages and serviced almost all of them, while nonbank lenders did the rest. But in recent years, those numbers have essentially flipped. As of 2023, banks accounted for around 35% of originations and less than half of servicing, according to Treasury data.

Banks have been retreating from the mortgage market for several reasons. The mortgage business has thin margins compared to other common banking services, and rising rates have depressed business in recent years.

Regulatory changes that went into effect in the aftermath of the financial crisis also play a role. Those rules, designed to ensure banks have enough money set aside to cover losses on risky assets, made it more onerous for banks to hold mortgage loans and servicing rights on their books.

Nonbanks, meanwhile, are governed by a different set of regulatory requirements, often from states, and have worked to grow their businesses as banks stepped away. The added competition has made it even less enticing for banks to stay in the business.

On Thursday, Willamette Valley Bank, a community bank based in Salem, Ore., announced it was exiting the mortgage lending business, saying that higher rates and the growth of nonbank lenders were making it harder “to compete sustainably in this segment.” Last year, banks including Popular, Ally Financial, and WaFd Bank ended mortgage lending as well.

“Intense competition from nonbank servicers — many of which continue to expand their technological advantages — has materially compressed returns,” Mario Ichaso, senior agency residential mortgage-backed securities strategist at Wells Fargo, wrote in a note to clients last week.

Bowman’s proposal to bring banks back focuses on loosening some regulations by more closely linking the money a bank must set aside to risk factors, like the size of a mortgage and the borrower’s down payment, and changing how regulators value banks’ mortgage servicing rights.

Those changes would help free up more money banks could use for lending and entice them back into the market, with the added competition potentially helping bring down mortgage rates for consumers.

Eric Orenstein, senior director for nonbank financial institutions at Fitch Ratings, said the changes would likely lead to banks taking some mortgage lending business back from nonbank lenders and translate to lower rates.

“We would expect if there is increased competition, they'd be competing more aggressively on rates, and ultimately consumers would be able to pay a lower mortgage rate,” Orenstein said.

Still, mortgage rates are largely determined by external factors, including the health of the economy, Treasury yields, and demand for mortgage-backed securities. Adding new lenders into the market isn’t enough to drop rates from current levels of around 6% back to 4%, but more competition can incentivize lenders to beat competing offers by a few basis points or reduce fees associated with a loan.

Banks becoming more active in buying and selling mortgage servicing rights could also help push rates lower, said Michael Fratantoni, chief economist of the Mortgage Bankers Association, a trade group that has advocated for reforms like the ones Bowman is proposing.

“The yields on mortgage-backed securities are big drivers of primary mortgage market rates,” Fratantoni said. “But the value of the mortgage servicing asset is also a component. So if you make that asset more valuable, ultimately, that's going to result in better mortgage rates for consumers.”

In a speech last week, Bowman pointed to other potential benefits for consumers, saying that during the pandemic, borrowers with bank servicers were more likely to receive mortgage forbearance — payment relief during financial hardship — than those with nonbank servicers.

Still, other academic research has found that nonbanks have improved their servicing, particularly in communities with more low-income or minority borrowers, as they’ve grown and invested in technology.

Claire Boston is a Senior Reporter for Yahoo Finance covering housing, mortgages, and home insurance.

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