The Housing Chronicles Blog: Why the bump in jumbo loan amounts hasn't worked

Thursday, May 22, 2008

Why the bump in jumbo loan amounts hasn't worked

When the conforming loan limits were raised to accommodate more jumbo loans, it was thought that it would spark home sales activity in higher-priced areas, but that hasn't quite done the trick. A story examines why:

When the housing crisis hit last summer, it became very hard for borrowers to land the jumbo loans they needed to buy homes in high-priced areas, like California and New York.

So as part of the Economic Stimulus Act, Congress tried to get funds for jumbo loans flowing again by temporarily raising the dollar limits for mortgages that Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) can buy. The two government-sponsored entities (GSE) had previously only been permitted to buy so-called conforming loans of up to $417,000, and then resell them on the secondary market.

The new limits raised that conforming loan cap to as much as $729,750 in some high-priced metro areas through December 31, in order to make home loans more readily available to help stabilize falling markets.

But the move hasn't juiced the market, and so the House Financial Services Committee is holding a hearing Thursday to examine why that is...

Despite the increased caps, these new 'conforming jumbo loans' - for anything between $417,000 and $729,750 - are still more expensive than the conforming loans below $417,000.

For months after the conforming jumbos were introduced, interest rates for them ranged between a point and a point and a half higher than on regular conforming loans. That made jumbo loan borrowing much more expensive; for a $600,000 mortgage, a borrower paid an extra $400 to $600 a month.

In the past, the spread between jumbo and conforming loans was much smaller, a quarter point or so...

The problem: The investors who buy mortgages on the secondary market still consider these new conforming jumbo loans riskier than the original conforming loans, and put a higher risk premium on them...

That reluctance comes despite the fact that buyers who use jumbo mortgages tend to be better credit risks and often put more money down, McDonald said.

Part of the problem is simply that fear is contagious...

ndeed, Fannie and Freddie don't actually package conforming jumbos for sale to investors in the same way they treat sub-$417,000 conforming loans. They are not what's called "TBA-eligible." These are "to-be-announced" transactions where the purchase price is settled at some future date.

The Securities Industry and Financial Markets Association decided back in February to exclude jumbo conforming loans from TBA-eligible pools. But the TBA market is well established and understood by investors, according to Jay Brinkman, an economist with the Mortgage Bankers Association (MBA).

"Buyers of securities feel very secure about this market," he said. "They're accustomed to the pricing and they know how the securities perform."

The exclusion of conforming jumbos from that market makes them a somewhat unknown security. "No one is sure what their performance will be, so no one is sure how to price them," said Keith Gumbinger, of HSH Associated, a publisher of mortgage market information.

The Mortgage Bankers Association (MBA) argued that the new conforming jumbos should be issued as TBA products, but there was resistance to this. Fannie and Freddie were hesitant to introduce any new element that might harm the conforming loan market...

Jumbo borrowers are more likely to pay off their loans early, which cuts off the revenue stream of their interest payments for investors, while those with $100,000 mortgages tend to keep making the same monthly payment year after year.

If jumbos were packaged with these in the same mortgage-backed securities, investors would require higher interest rates to purchase them. Borrowers of conforming loans would have to pony up the increased interest, in effect subsidizing more affluent, jumbo loan borrowers.

There are other risk factors that makes investors wary. Jumbos are, by definition, less diverse geographically; they're only available in about 70 metro areas - many of the most challenging markets in the nation...

In early May, Fannie made a change in the way these loans are handled; instead of packaging them for sale on the open market, they are keeping them in their portfolios. Fannie can set the price itself and is doing so as if the loans were TBA-eligible.

As a result, the pipeline for the loans has opened up during the last couple of weeks.

Weekly mortgage application statistics from the MBA reveal the change. In March, 2007, 12.1% of all mortgage loans requests were for jumbos. A year later, only 4.4% were. During the past couple of weeks, jumbos have accounted for 5.8% of all applications.

According to Freddie Mac Vice President Patricia Cook, interest rates for conforming jumbos are now a full point below regular jumbos and only two-tenths of a percentage point higher than conforming loans.

Gumbinger confirms that spreads between conforming and jumbo conforming have narrowed down to below half a point, good news for home buyers in high-priced areas.

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