Cryptocurrency and the Mortgage Industry

A bitcoin against a background technical grid.

Over the last decade, cryptocurrency transformed from a highly speculative idea into a viable investment. 2021 saw huge growth and adoption. Companies like Paypal, Square, and Tesla began accepting digital currency. Retailers like Walmart and Amazon started positioning themselves for growth that incorporates digital currency.

While crypto loans are already available, a few mortgage companies are testing the waters for home purchases. It is only a matter of time before the regulations are in place that will allow it to be used for mortgages.

What is Cryptocurrency?

In 2008, a programmer suggested the concept of cryptocurrency in a white paper, which described a digital form of currency. As a digital token, one could use it to purchase goods and services through a blockchain. A blockchain is a shared ledger that facilitates the process of recording transactions and tracking assets. The integrity of the data remains secure because information is shared among networks and cannot be edited.

By January 2009, the Bitcoin network became a reality. Since then, cryptocurrencies have experienced many rallies and crashes and remain a very volatile asset class. However, once institutional investors began embracing Bitcoin in 2019, the value increased from a mere $13.29 to $6,965. Bitcoin rose as high as $19,157 by the end of 2020.

January 2021 saw Bitcoin value surpassing $40,000. It fluctuated between $30,000 and $64,000 from April 2021 and October 2021. By November 2021, it rose as high as $67,000. Its price has dropped back to $35,000 at the end of January 2022. The first week of February shows small gains, and by February 7, 2022, it was at $42,000.

While investors may have experienced losses if they bought high, $42,000 is a huge gain from its $13.29 beginnings.

Supply and Demand

Bitcoin was designed to only allow a total of 21 million. Currently, there are $18.9 million bitcoins mined with only $2.1 million remaining. This limitation means that the law of supply and demand will drive prices higher if demand remains constant. Mining is accomplished through specialized software and hardware. It is created when an increasingly difficult mathematical problem is solved.

This asset class is not currently regulated by countries around the world. For example, in the United States, the SEC views cryptocurrency as a security, while the CFTC calls it a commodity. The Treasury calls it a currency and the IRS classifies cryptocurrency as property for federal income tax purposes. It is the newness of this currency that creates both the risk and reward for those unafraid to invest.

The US and other countries around the world are moving to develop regulations for cryptocurrencies. China made cryptocurrency illegal, while El Salvador adopted it as its national currency. The future of cryptocurrency presents many challenges, but includes enormous possibilities.

Crypto Loans

A crypto-backed loan is just another type of secured loan. Borrowers can use digital assets as collateral in the same way a house or a car is used. These loans often have low interest rates and are processed more quickly than traditional loans.

The upside is that it allows someone who holds a substantial amount of crypto to liquidate it. Therefore, they do not actually sell it with tax consequences.

The downside is that a lender can request a margin call on crypto-backed collateral. The borrower might need to put up more cryptocurrency in order to maintain the value of the initial pledge. The lender can set a threshold. If the value of the pledged crypto declines, there is a set period to pledge additional crypto.

Cryptocurrency and the Mortgage Industry

There are a few mortgage companies moving into the cryptocurrency space. However, the volatility and lack of regulations have led lenders to use waitlists. Some are only offering the loan during a small trial period.  

In addition to fluctuating value on collateral, crypto loans are also not federally insured. Additionally, the secondary mortgage market appears to be creating regulations. These regulations will affect the primary mortgage market and the use of cryptocurrency.

Buyers and sellers of homes may be skeptical about using cryptocurrency for real estate transactions. Finding a mortgage company, title insurance and escrow company that will handle virtual currency presents similar challenges. Until the tax structure on gains and regulations are defined, crypto mortgages will have difficulty going through normal underwriting.

Mortgage companies can require the buyer to cash out and season the cash in their bank account for 2 months. This is required prior to using it as a down payment.

Secondary Mortgage Market

Freddie Mac released a bulletin in December of 2021 about cryptocurrencies. It outlines their requirements for loan originators who wish to resell mortgages to Freddie Mac:

  • Income paid to a borrower in cryptocurrency may not be used to qualify for a mortgage;
  • For income types that require evidence of sufficient remaining assets to establish likely continuance (e.g., retirement account distributions, trust income and dividend and interest income), those assets may not be in the form of cryptocurrency;
  • Cryptocurrency may not be included in the calculation of assets as a basis for repayment of obligations;
  • Monthly payments on debts secured by cryptocurrency must be included in a borrower’s debt payment-to-income ratio and are not subject to other criteria regarding installment debts secured by financial assets; and
  • Cryptocurrency must be exchanged for US dollars if it will be needed for the mortgage transaction (i.e., any funds required to be paid by a borrower and any borrower reserves).
  • The bulletin also notes that Freddie Mac will continue to monitor cryptocurrency developments and may update its requirements as appropriate in the future. The new cryptocurrency criteria are effective immediately.

Fannie Mae allows people to use cryptocurrency funds for their down payment with the proper documentation that proves the borrower owned the digital currency. However, they require that it is converted into dollars and seasoned for 2 months.  

As of today, cryptocurrency as a currency is still not universally accepted as an eligible source of funds during the underwriting process. However, cryptocurrency is beginning to be viewed as an asset when applying for a mortgage. You can't pay with crypto assets, but they may be evaluated as part of your overall assets.

Milo, one of the first lenders to begin rolling out a crypto mortgage product has 5,800 borrowers on its waiting list. As regulations are ironed out and retailers push crypto adoption, it is only a matter of time before we see adoption in the mortgage industry.

Contact me today for more information about buying or selling your home at Lake Tahoe.