Jumbo Loans and The Current Market (January 2009)

One of the salient facts of the current loan market is the fact that pretty much nobody is offering "jumbo" loans at anything like a "par" rate

One of the saving graces is that this is a lot less meaningful than just a couple of years ago. In 2005, the conforming loan limit was $359,650, and the median sale in San Diego County was almost $600,000. This meant that for the typical purchase, unless you had a 40% down payment you were looking at a "jumbo" loan even if you were both "A paper" and full documentation. Once you paid a "jumbo" amount, you had to wait years for the conforming limit to catch up to your mortgage. VA and FHA limits were even lower. Well, now both the FHA Limit and the OFHEO conforming loan limit have gone up (to $546,250 for single family residences in San Diego), while the median price of housing has gone down by roughly 30%. This means that if it were possible to get a median priced property without a down payment, it would still be a conforming loan. Yes, the decline in values has meant a lot of pain for overextended borrowers and especially the lenders who loaned them the money, but right now we're looking at the situation for buyers, and providing you've got a 3.5% down payment (or VA eligibility) and a credit score that's not putrid, the situation is pretty darned rosy for buyers. People can qualify for properties they wouldn't have had a prayer of getting, even before the run up in prices we've had the last few years - with a full documentation, thirty year fixed rate mortgage, to boot. The vast majority of the properties out there can be had with conforming loans.

Those relatively few properties that are the exceptions, however, are in a world of hurt. While conforming rates have nose-dived (below 5% if you're willing to pay at least part of a point, mostly just above if you're not), "jumbo" rates for loans above the conforming limit are still high. Not only that, but the lenders offering them don't want to offer anything like a so-called "par" rate. This means that "no points" loans basically don't exist for Jumbo loans. You can get something in the mid to high 6s on a thirty year fixed rate loan if you're willing to pay two to three points, but the only "no points" loan offered from any of my eighty-plus lenders today carried a rate of ten percent. Yep, double digits. I haven't seen rates like that since about 1994.

There's a reason for all this. Right now the markets are very nervous about jumbo loans. Why? Because on the secondary mortgage bond market, they are traditionally part of the same nonconforming market as stated income loans - which were one of the root causes of the meltdown. Nobody wants to buy those bonds, because of the default rate they have been subject to for the last couple of years due to stated income shenanigans. Yet with stated income all but dead (a few portfolio lenders are willing to do them. Ask me if you have a need), the lenders are well aware that the secondary mortgage markets are going to figure it all out soon, after which jumbo rates are likely to fall. Upshot: They will have funded all of these loans, paid the salaries of the people necessary to fund them, etcetera, and then not made a profit on the loans. So they want a stroke of profit they can show their stockholders and investors right up front. This profit is taking the form of discount points. For brokers and correspondent lenders, I can't find a single jumbo loan in the sixes or sevens that the lenders are willing to pay as much as ninety-nine cents on the dollar for - which means they (we) have to charge discount amounting to more than one full point just to break even - and in the real world, nobody does loans just to break even. They can call it discount, they can call it origination, they can call it a the hokey pokey, but it all amounts to the same thing in this case. The lenders want what amounts to an immediate profit on the loan in the form of cash paid, to make up for interest they don't think they'll be getting later.

There is always a tradeoff between rate and cost on real estate loans, but the lenders can change that tradeoff in light of current market conditions. A traditional tradeoff between rate and cost is about two points of cost for one percent on the rate of the loan. For conforming rates right now, the tradeoff has gotten much steeper in the "below par" range. When I was looking at rates today, I could do 4.75% for one total point, but buying the rate down to 4.25% would cost almost the California statutory limit of six points. The lenders set that kind of tradeoff to discourage people from getting rates below par because they don't want to be stuck carrying a 4.5% loan for thirty years. But for "jumbo" rates, the tradeoff is as shallow as as the tradeoff for conforming is deep. 6.375 could be had for three points, 6.875 for two - standard enough between those two points - but to buy the total points down to zero, you had to go all the way up to ten percent - a difference of over three percent to buy off two points - less than one sixth of the traditional margin. FYI, it takes about eight months to break even on that kind of slope between the two points. Save two percent on initial costs, spend three percent per year on the rate. There are exceptions, but if you think you'll be able to refinance at a lower rate in eight months, it's generally going to be a better idea to wait. However, if you are one of those exceptions, for instance, someone whose short term hybrid has adjusted to nine and a half percent, you are being very strongly encouraged to pay two to three points to refinance. The zero points loan doesn't do you any good, and so if you can't afford your current rate, you're going to have to come up with 2-3 percent of the loan amount from somewhere - cash or your equity.

The tradeoff on jumbo hybrid ARMs is similar. For one of my long-time favorites, the hybrid 5/1 ARM, the curve looked very similar, albeit shifted downwards a significant bit: 9.125 for no points, 6.375 for two, 5.75 for three, and you could get as low as 4.875 if you were crazy enough to want to pay nearly six points.

(lest anyone be mistaken, by the time this article is published, these rates will be yesterday's rates, and one thing you can count on in the "A paper" loan world is that tomorrow's rates may be similar, but they will be at least slightly different. I looked at rates what will be day before yesterday to do a Real Loans for Real People but didn't get it posted, so had to do it all over again what will be yesterday. As is the case about 75% of the time, Tuesday's rates were slightly better than Monday's)

I am normally a big fan of low to zero points loans, or even zero cost loans. I normally get a lot more hardcore about that preference for jumbo loans, because on jumbo loans one point is anywhere from a minimum of $5500 on up, and the last set of government statistics I saw show most people refinance at intervals of about 28 months. But at today's jumbo rate/cost tradeoffs, in 28 months you have recovered those two or three points of initial cost about three and a half times over. That is likely to make those two or three points the lenders want for a reasonable rate likely to be an investment that is well worthwhile. Even if you do refinance before then, it only takes about eight months to break even. I am pretty certain jumbo rates are going down within the next year or so, but I can't tell you exactly when, and if anybody thinks they can, ask what kind of insurance they're willing to sell you and at what price. Chances are that if you are one of those people who has a jumbo loan and a good reason to refinance now, the cost of refinancing now will be cheaper and doing so will serve you better than than any such insurance policy.

Caveat Emptor