Over the past week, everyone has been going gaga over the fact that mortgage rates are now lower on jumbo loans than conforming loans.
For the record, the data came from the Mortgage Bankers Association, which noted in its weekly mortgage application survey release that 30-year jumbos averaged 4.71% during the week ending August 20, compared to 4.73% for conforming loans.
So before we get into it, note that jumbo loans are, on average, a measly two basis points below conforming loan rates.
I will say that while the difference is perhaps negligible, the spread has come down significantly over the past couple years.
In fact, there was a time not too long ago when jumbo loans priced nearly two percentage points higher than conforming loans, just after the terrible crisis when no one would originate a loan without a guarantee from Fannie Mae or Freddie Mac.
Historically, the spread favors conforming loans, which tend to price anywhere from .25% to .50% lower than jumbo loans.
Why Are Jumbo Loan Rates Lower?
Since the “historic moment” took place a week ago (see CBO image above, it’s not that rare), a number of financial pundits have been trying to wrap their heads around it.
Nick Timiraos over at the WSJ likened the phenomenon to banks holding the loans on their books and thereby setting their own price without the need to look to the bond market for direction.
He added that banks have been able to market jumbos to their wealthiest clients, cross-selling stock brokerage accounts and other wealth services along the way.
But Felix Salmon of Reuters debunked most of those explanations as “unpersuasive,” and instead believes it is the government working to exit the mortgage market and level the playing field.
Put another way, he believes the FHFA has tacked on higher guarantee fees to loans sold to Fannie and Freddie, which makes such loans more expensive compared to loans kept on the banks’ books.
This is all intended to usher back in private money to a mortgage market largely dominated by the government.
So in a sense, it’s more about conforming loan rates rising more than jumbo loan rates lately, not necessarily jumbo loans getting any cheaper.
Then there’s Matt Levine over at Bloomberg, who argues that it’s not really that “weird” at all. His point is that Fannie and Freddie have long subsidized conforming mortgage rates by charging below-market guarantee fees.
Now that they’ve raised them to levels more in-line with actual risk, mortgage rates are pricing more similarly across conforming and jumbo loans.
He also brought up an interesting accounting rule. Essentially, when mortgage-backed securities held by banks lose value (as rates rise), they are required to raise capital to meet federal requirements, whereas whole loans held on banks’ books can be considered at their original value.
Because of all the recent taper talk, agency MBS have taken a serious hit, which has likely hurt the banks that hold them. This favors Levine’s argument of holding loans instead of securitizing them, especially if Fannie/Freddie charge more to do the latter.
Forget the Jumbo Rates, Focus on the Jumbo Guidelines
Regardless of who is right here, there’s a bigger problem with jumbo loans. One shouldn’t focus on the rates, which actually should be higher than those offered for conforming loans in most cases.
Why? Because jumbo loans historically carry more risk than conforming loans. One reason is faster prepayment, which hurts investors of jumbo loans.
In short, jumbo loan borrowers benefit more from lower rates (and refinancing) because they have more to gain in the way of interest savings, so they’re prepaid more often.
After all, why refinance a $100,000 loan if rates drop 1% or so. On a large loan, it becomes attractive a lot faster, which is why no single refinance rule works.
Jumbo loans are also more risky because they’re tied to more expensive homes, which tend to fluctuate more in value. Lenders can also lose more money on a larger loan.
And there is even data that jumbo loans default at a higher clip than conforming loans, though I can’t seem to find it at the moment.
Anyway, the focus should be more about credit availability than interest rates. Jumbo loans still have the toughest underwriting guidelines out there, such as substantial down payment and credit score requirements.
These are the issues that make jumbo loan lending a problem, not slightly higher rates. I would guess most borrowers would be happy enough just to get a jumbo loan with 20% down rather than receive a quarter percent off their rate.
In other words, even if jumbo rates are slightly lower, most borrowers probably won’t even qualify anyways.