July 30, 2010 (FreeRateUpdate.com) – The difference between conforming mortgage loans and jumbo mortgage loans is simple: lending standards are set by two government-sponsored enterprises (GSE), Fannie Mae and Freddie Mac. Loans that conform to those standards are known as “conforming” loans and those loans that are non-conforming are known as “jumbo” or “super jumbo” loans. Although the definitions are simple enough, due to their comparable riskiness, jumbo mortgage loan rates have historically trumped those of conforming mortgage loans and were virtually unattainable for many borrowers. However, that is not the case today. Market conditions are such that the interest rates on conforming and jumbo loans are only marginally different.
Since the 1970s, Fannie Mae and Freddie Mac have established the guidelines for lending. Each year, these two GSEs set the terms and conditions for loans. As previously mentioned, those that meet the criteria are known as conforming loans. The national conforming loan limit is $417,000 in the continental U.S. and $625,500 in Alaska, Hawaii, Guam and the US Virgin Islands. Conforming loans are purchased by Fannie Mae and Freddie Mac, packaged into mortgage-backed securities, and sold to investors. This practice allows the GSEs to create a pool funds for lenders to provide home financing and increases the availability of credit to borrowers. The current interest rates for conforming loans are: 4.250% for 30 year fixed, 3.625% for 15 year fixed, and a 5/1 adjustable is 3.375%.
Those loans that exceed the loan limit set by Fannie Mae and Freddie Mac are non-conforming loans, most commonly referred to as jumbo loans. The interest rates of jumbo mortgage loans are higher than conforming loans in order to offset the risks involved in funding these loans. Not only would a lender have more money to lose if a jumbo borrower should default on a jumbo mortgage loan, but also the location and economic conditions of the asset make it difficult for these homes to sell. Jumbo mortgage lenders typically require a better than average credit history, a 36% to 38% LTV ratio, a higher down payment (usually around 20%,) and two appraisals of the home to better assess its value. Although jumbo loans are riskier, their current interest rates are approaching those of conforming loans. The current rates as of this writing are: 5.125% for 30 year fixed, 4.500% for 15 year fixed, and 3.625% for 5/1 adjustable.
Since 2007, Fannie and Freddie have tightened lending standards in response to the subprime mortgage debacle. Last week, President Obama signed the Dodd-Frank bill into law. The Dodd-Frank bill allows the government to identify “systemically risky institutions” (SRIs) and dismantle them; it forces banking institutions to have more capital available, which aims to prevent risky investing; and it creates a new consumer financial protection bureau that will enforce regulations relating to, but not limited to, home mortgage loans. Banks are wary of a government take-over and subsequent liquidation. The stricter lending standards have provided a business opportunity for lenders; hence banks are incentivized to provide more options for borrowers, such as the jumbo mortgage loan.
Jumbo borrowers could require financing in the millions of dollars. Banks, such as Bank of America and Citigroup, recognize that it is a Louis Vuitton market and adjust their business strategies in order to remain in the lending game. Bank of America claims to have always been the leader in the jumbo loan market. It reports an increase in jumbo loan applications by 10% from May to June. Citigroup is following suit. It reports an increase of 30% in jumbo mortgage loan applications. Citi’s strategy is to take advantage of the low interest rates and revive its 1,000 retail bank branches by providing consumers with more options. The bottom line is this is business and those banking institutions that desire to play, must adjust accordingly.