There has been a disruption in market equilibrium as rates for jumbo loans dipped lower than rates on smaller loans which the government insures.
What is a “jumbo” loan? Jumbo loan amounts vary greatly by state and county. By definition, jumbo loans are loans for an amount above conventional conforming loan limits. This standard is set by Fannie Mae and Freddie Mac and sets the limit on the maximum value of any individual mortgage they will purchase from a lender. Fannie and Freddie are large agencies that purchase the majority of U.S. residential mortgages from banks and other lenders, allowing them to free up liquidity to lend more mortgages. When their limits don’t cover the full loan amount, the loan is referred to as a “jumbo mortgage”.
Under normal circumstances, there is no full government insurance on jumbo loans. So it’s a little strange that these rates, normally determined at least in part by the degree of credit risk, are lower than loans fully insured by good ol’ Uncle Sam. So how did this happen?
Well, since the financial crisis of 2008, the mortgage market has had two substantial sources of government support. First, government entities have been backing a far higher proportion of mortgages than normal. While individual banks and lenders create these loans, they usually do not hold onto and service them. Instead, they package and sell nearly all of them to investors, like pension and mutual funds. The second arm of support has come from the Fed’s buying of large amounts of those taxpayer-backed mortgage bonds in order to stabilize the economy overall. This has greatly contributed to the historically low interest rates as of late.
Great! Except that the Fed, believing the economy is gaining strength, has now signaled that it may soon buy fewer of these bonds. Consequently, their price has fallen. This pushes up the yields on the bonds, which in turn drives up mortgage rates for people taking out new conforming home loans. The rates on jumbo loans have risen over the last few months too, but because fewer jumbo mortgages trade in markets, they are less vulnerable to big swings in investor sentiment.
So, while the government backed behemoths jack up fees to insure loans, lending privately to those with great income suddenly isn’t so terrible – even without an insurance policy.Tweet