Last year was a terrible year for the mortgage space. The Fed raised the Federal Funds rate aggressively in order to combat inflation, which pushed up mortgage rates to the highest level in years.

UWM Holdings (UWMC 2.68%) is the parent company of United Wholesale, which is the largest mortgage originator in the United States. While most companies were experiencing a collapse in volume, UWM held up better than most. What is its secret? 

Picture of a house, a stack of money and a calculator

Image source: Getty Images.

UWM Holdings follows the broker model

In mortgage origination, there are basically three general business models. There are very few pure plays, but most originators do tend to focus on one business model.

The most common business model is retail, where the originator sources its own loans, assembles them, and then either puts the loans on its balance sheet or sells them into the market. This is the model that Rocket Companies (RKT 1.20%) uses. It sources customers via its app, and then securitizes and sells its production. Your local credit union has a similar model. Retail originators tend to have the highest profits on a per-loan basis, but their costs to produce a loan are higher as well. 

The next model is correspondent lending, where the lender buys loans that have already been assembled from smaller originators and then flips them into the market for a small profit. This is the business model that Mr. Cooper Group (COOP 1.10%) uses. Mr. Cooper generally hangs on to the mortgage servicing rights and sells the loan into the market.

Lastly, there is the broker model, which is what UWM uses. In this model, the mortgage broker is the customer, not the borrower. The mortgage broker finds the borrower and then gives it to United Wholesale to assemble and sell.

The biggest difference between retail and broker models is that the borrower is the customer to a retail lender and the broker is the customer for a wholesale shop. 

Refinancing activity is drying up

Over the past year, the mortgage market shifted dramatically from a refinance market to a purchase market. Half of all mortgages in the United States have a rate of 3.5%, and two-thirds have a rate under 4%.

With mortgage rates on new loans hovering close to 7%, there is little to no refinancing business. Nobody is going to swap out a 3.5% mortgage for a 7% one. This means most of the loans that originators will be doing will be purchase loans. 

The home-purchase market is a relationship-driven model

A purchase market is ideal for UWM's wholesale model. Here is why: The purchase market is still mainly a face-to-face business. Real estate agents represent buyers and sellers and will often make recommendations to the buyer. The mortgage broker is close to real estate agents, closing attorneys, and title agents, and the broker sources loan leads from his or her network.

UWM has made it easy for mortgage brokers to close loans, with good visibility into where the loan stands at any one time. This relationship aspect of the business puts UWM in a better competitive position than retail originators that primarily use technology or cold-calling to find loans, at least in a purchase market. 

Mortgage banking is a highly cyclical business, and right now we are stuck in the bottom of the cycle. Home affordability concerns are slowing purchase activity, and rates are too high for people to refinance their mortgages.

If the U.S. enters a recession toward the end of the year, we might see the Federal Reserve begin to lower rates, and that could ease the affordability issue and benefit UWM. Until then, it is hard to recommend any mortgage banker until the Federal Reserve is done with its rate hikes.