Tuesday, December 31, 2013

The Return of the Jumbo

Remember those damnable jumbo mortgage loans of the housing bubble?  Well, like the Terminator,  according to Inside Mortgage Finance, "they're back"!

As a bit of background, jumbo mortgages are home loans that exceed the limits imposed by Fannie Mae and Freddie Mac.  In most parts of the United States, these two GSEs limit mortgages to $417,000 with a "conforming limit" of $625,500 in some of the most expensive real estate markets (100 out of the 3300 counties in total) in the United States.  Jumbo loans are generally taken on properties ranging in price from $750,000 to $10 million and a borrower must have a minimum credit score of 700 with a debt-to-income ratio of no more than 45 percent and a 20 to 40 percent downpayment.  Jumbo loan holders also require a higher reserve base than normal loans and, in normal circumstances, have a higher interest rate than conventional mortgages.

Let's start with a bit of history.  Here is a graph showing the conforming limit in dark blue, the average price of an American home in pink, the average sale price of a home financed with a jumbo loan in medium blue and yellow and the average size of a jumbo mortgage taken out on these homes that were priced higher than the conforming limit:

Between 2002 and 2006, banks originated an average of $557 billion annually in jumbo mortgages.  There's your housing bubble!

The volume of jumbo mortgage originations more than tripled between 1993 and 2005 as shown on this bar graph:

Now, let's go back to the present.  Here is a graph showing the interest rate on a 30 year fixed jumbo loan over the past three years:

Here is a graph showing the interest rate on a 15 year fixed jumbo loan over the past three years:

Here is a graph showing the interest rate on a 15 year fixed regular loan over the past three years:

The current rate on a 15 year fixed mortgage is 3.47 percent.  The current rate on a fixed 15 year jumbo is only very slightly higher at 3.50 percent.  In fact, back in September 2013, the rates on jumbo loans were lower than the rates on regular loans, an event that has never happened before.  Normally, the rate on jumbo loans is at least 0.25 percent higher than the rate on regular mortgage loans, in fact, during December 2008, the spread reached 1.8 percentage points.  Why is this historically unprecedented relationship taking place?  There are several reasons:

1.)  Volatile interest rates that have pushed up yields on mortgage bonds issued by Fannie Mae and Freddie Mac which has translated into higher interest rates on "conforming loans".

2.) Higher fees charged on "conforming loans" because Federal officials are reducing the exposure of Fannie and Freddie which have been passed along to consumers.

3.)  Banks are flush with cash on deposit and want to loan that money out.  Jumbo mortgages are kept on bank balance sheets meaning that interest rates are not set by the bond market.  Higher interest rates since late spring have meant that banks are increasingly willing to loan higher amounts of money to their wealthier clientele.  Some banks are offering special discounted mortgage rates for clients that maintain high balances in savings and brokerage accounts in an effort to attract borrowers. 

All of this has led to an increase in total jumbo mortgage originations over the past year.  In the second quarter of 2010, jumbo mortgage lenders originated a tiny $18 billion in loans and that was up 20 percent over the first quarter volume.  In the first three quarters of 2008, only $87 billion of jumbo loans were originated.  If we look at the present situation, we find the following jumbo loan originations by quarter for 2013:

Q1 2013 - $97 billion
Q2 2013 - $105 billion
Q3 2013 - $102 billion 

Jumbo loans have increased by 34 percent on a year-over-year basis, a rather impressive increase.  Obviously, banks and borrowers feel that history will not repeat itself.  Banks feel that their very well-heeled clients are less of a risk than the rest of us.  That said, let's look back at a bit of history that seems to be forgotten already.  During 2008, the number of delinquent jumbo loans skyrocketed as shown on this graph:

Apparently, even America's wealthy are immune from the humbling experience of defaulting on a mortgage.  The large number of jumbo loan defaults led to a massive downgrade of mortgage-backed securities that were held by the two top originators, Chase Home Finance and Washington Mutual.  That was, in large part, responsible for the collapse of WaMu in 2008.

The current low interest rate environment has had a wide range of what could ultimately be very negative impacts on the economy.  The recent resurgence in housing prices has been predicated on low interest rates.  When the Fed ends its unprecedented experiment, we could well see a repeat of history with even wealthy Americans walking away from their jumbo mortgages.

1 comment:

  1. A huge issue is the standards that had to be met to secure a jumbo loans. What were the actual (not nominal) standards before 2008 and what are they now?

    A separate question--were jumbo loans kept on banks' books before?