Future of Mortgages, part 9: Jumbo Is Back Full Force

Mortgage loans have three rate tiers: (1) lowest rates for conforming loans up to $417,000, (2) .125% to .25% higher than tier 1 for super-conforming loans from $417,000 to $729,750, (3) .125% to .375% higher than tier 2 for jumbo loans above $729,750.

The first two rate tiers are lower because Fannie Mae and Freddie Mac buy these loans from your lender (though you usually still get statements from lender) so lenders have built-in liquidity and less risk. The third tier is highest because these loans are ineligible for sale to Fannie/Freddie due to size. On October 1, more loans will be ineligible as the cap is reduced from $729,750 to $625,500. Time to panic? Or just a new step toward recovery?

I think it’s a step toward recovery of credit markets, and it’s a good thing because private markets must take up more slack on lending.

Fannie, Freddie, and FHA have controlled most of the home lending market since the crisis hit critical mass in 2008.

Up to that point, Fannie/Freddie conforming loans were capped at $417,000. The super-conforming loan caps of $729,750 were implemented March 6, 2008 as the crisis got worse and jumbo lending was non-existent.

Now, as part of weaning private markets off of government help (and winding down Fannie and Freddie), the Fannie and Freddie limits are being pared back slightly.

Not all the way to the original $417,000 limit. Just to $625,500.

No big deal.

Here’s what consumers must remember:

This loan limit reduction has been known and planned for throughout the mortgage industry since January.

That’s why we’ve seen the Jumbo market re-emerge since then after laying dormant during the three years Fannie/Freddie were allowing up to $729,750.

There is (and will continue to be more) reliable, competitive loan options from $625,500 to $2m.

I say this as a mortgage banker who’s watched our jumbo loan options grow rapidly in the past six months alone.

Here’s a summary on the re-emergence of jumbo as I’ve seen it in my own company during 2011:

Property types
-started with single family homes.
-now we can also lend on condos and 2-4 units

Down payment requirements
-started with 25-30%
-now 20%

Qualifying parameters (income)
-started with max 35% debt-to-income ratio
-now max 40% debt-to-income ratio
-Note: Fannie/Freddie allows up to 45% ratios

Qualifying parameters (assets)
-started with 36 months reserves required after close
-now must have 12-24 months reserves
-Note: Fannie/Freddie/FHA allow 0-6 months reserves

Qualifying parameters (credit)
-started with 740 credit score or greater
-now can lend down to 700 credit (but rates are worse)

Loan types
-started with 5yr ARMs
-now have 30yr fixed and 7yr and 10yr ARMs
-now have interest-only options on ARMs

Appraisals
-started with 2 appraisals on all transactions
-now only 1 appraisal for loans from $625,500 to $1m

Rates and fees
-started with rates .5% to .75% above super-conforming
-now that spread is .125% to .375%
-underwriting $100 more than conforming

As you can see, credit markets are regaining their risk appetite without conceding to flimsy approval guidelines of the years leading up to the crisis.

This will continue to October, and the jumbo marketplace will be better able to accommodate the reduction of Fannie/Freddie limits.

And in my view Fannie/Freddie should go back down to their single-tier limits in order for private credit markets to continue evolving.

But I don’t see that or any other meaningful movement on Fannie/Freddie until after the 2012 presidential election.

Meantime, here’s what to look for in a jumbo lender.

[This is the latest in The Basis Point’s Future of Mortgages series]