Want a Cheaper Mortgage? Buy a Bigger House

For the first time in history, the interest rate on jumbo mortgages is lower than that on conforming mortgages.

Data released yesterday by the Mortgage Bankers Association showed that the average interest rate for a 30-year fixed-rate mortgage with a conforming loan balance ($417,000 or less) came in at 4.73% last week. Meanwhile, the rate for a mortgage with a nonconforming loan balance (greater than $417,000) was 4.71%.

According to an industry executive quoted by The Wall Street Journal, "In my 30-year career, I've never seen nonconforming loans priced below conforming loans."

At first glance, it's hard to understand how this could happen. It's axiomatic that the interest rate on a loan is principally a function of credit risk. The higher the risk of default, the higher the interest rate. The lower the risk, the lower the interest rate.

This is why conforming mortgages are one of the cheapest loans that an individual can get, as both the principal and the interest payments are guaranteed by Fannie Mae or Freddie Mac (and, by implication, the U.S. government). In other words, there is no credit risk.

Jumbo loans, on the other hand, aren't similarly risk free. Because jumbo balances exceed the level that Fannie or Freddie will insure, they carry the ever present threat of default. If the mortgagee goes broke, there's no one to backstop the payments.

As the recovery in the housing market has progressed, however, the spread between these two rates has compressed. And this trend has been particularly pronounced over the past three months -- that is, following the Federal Reserve's announcement that it may soon begin to tailor its monthly open market purchases of mortgage-backed securities.

At the beginning of May, the cost of a conforming mortgage was 20 basis points less than that of a jumbo mortgage. By the beginning of June, the spread had been cut in half.

The explanations for this are twofold. On a policy level, both the Fed and the Federal Housing Finance Agency (the governmental body that oversees Fannie and Freddie) have created an environment in which it's less lucrative to originate smaller mortgages that are then sold to the government-sponsored enterprises.

The Fed has done so by driving down the price of mortgage-backed securities that are collateralized by conforming mortgages. And the FHFA has done so by increasing the cost of their guarantee.

Meanwhile, the banks have responded in kind. In the first quarter of this year, for instance, Wells Fargo (NYSE: WFC  ) , the nation's largest mortgage originator, retained $3.4 billion in new conforming mortgages on its balance sheet as opposed to passing them onto the GSEs. And in the second quarter, one of its main areas of growth was in nonconforming mortgages.

In addition, the market for private-label securitizations collateralized by jumbo mortgages is finally getting back up and going again -- though haltingly so. Earlier this year, JPMorgan Chase (NYSE: JPM  ) and EverBank (NYSE: EVER  ) teamed up to manufacture and then market a $1 billion offering of this sort.

As my colleague Amanda Alix noted at the time, "Although these MBSes are not backed by any government agency, ratings agencies consider them less risky than you might think -- for a couple of reasons. Most of these loans are made to wealthy people with high credit scores, and down payments are typically high, around 65%."

The takeaway here is simply that the mortgage market remains exceptionally volatile and unpredictable -- though, at least in terms of the latter, what market isn't? While I believe rates are bound to increase over the longer term, it's anybody's guess what will happen in the meantime.

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  • Report this Comment On September 05, 2013, at 2:24 PM, Loanspecialist55 wrote:

    I work for a mortgage broker and see rate sheets from over 25 banks daily and none of the rate sheets have the conforming 30 year fixed rate lower than the jumbo 30 year fixed rate.

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