Jumbo Loan Rates – Are They More Affordable?
Are rates on jumbo mortgages going to rise soon? Is now the time to take on a jumbo mortgage? This article explains how rates on jumbo mortgages compare to traditional mortgage rates. It also covers what the future may hold for jumbo mortgage rates.
What are jumbo mortgages?
When it comes to understanding jumbo mortgage interest rates, it’s important to understand what a jumbo mortgage is. A jumbo mortgage is a mortgage that is too big for government-sponsored enterprises — Fannie Mae and Freddie Mac — to buy.
Fannie and Freddie purchase, guarantee and resell (securitize) close to 80% of all mortgages issued in the United States, and those loans are conforming mortgages. However, they won’t securitize mortgages that fall outside of conforming loan limits.
Conforming mortgages meet a variety of standards that include a borrower’s credit score, the size of their down payment, the borrower’s debt-to-income ratio and the size of the loan. Jumbo mortgages don’t meet the size standard set by Fannie and Freddie. “These are government sponsored entities, so they are trying to target the middle of the market, not luxury housing,” explained Tendayi Kapfidze, chief economist for LendingTree.
Throughout most of the United States, the conforming loan limit is $484,350. In some higher cost areas of the country, the loan limit is $726,525.
If you need to take out a mortgage that’s larger than the conforming loan limit in your county, you’ll take out a jumbo mortgage. “I think it’s important to understand that a jumbo mortgage isn’t some exotic creature,” Kapfidze said. “It’s just a mortgage that’s bigger than the conforming loan limits set by Fannie and Freddie.”
Jumbo loans aren’t just for wealthy homebuyers. In some expensive areas of the country, middle-income borrowers rely on jumbo mortgages to make their home purchases.
Jumbo mortgage rates yesterday vs. today
In the decades leading up to housing crisis, interest rates on jumbos were 0.15% to 0.30% higher than rates on conforming loans. Mike Fratantoni, chief economist for the Mortgage Bankers Association told LendingTree, “Most people attributed the lower interest rates to the increased liquidity provided by Fannie and Freddie.” Since lenders didn’t have to hold conforming loans, the rates were lower. Jumbo mortgages don’t share that advantage.
The lack of liquidity proved especially troubling during the housing crisis (2007-10). By 2009, interest rates on jumbo mortgages were 8% higher than interest rates on conforming loans. That year, 1.3% of mortgages issued were jumbo mortgages compared to 12.7% of mortgages in 2005. When banks did issue jumbo mortgages, they did so to practically perfect borrowers. Fratantoni told LendingTree, “During the financial crisis, it was common for lenders to require 25% to 30% down payments and pristine credit to take out a jumbo mortgage.” At the time, lenders looked at jumbo mortgages as a risky asset to hold on the books.
Since the financial crisis, banks have somewhat loosened standards, and jumbo lending has grown. In 2016, jumbo loans made up 5.2% of mortgage originations.
Today, jumbo mortgage rates are actually a little bit lower than rates on traditional mortgages. According to the Mortgage Bankers Association, the average rate on a 30-year fixed jumbo mortgage was 4.72% as of January 3. The average rate for a conforming 30-year fixed rate mortgages was 4.84%. What caused jumbo mortgages to have lower rates than traditional mortgages?
Kapfidze explained, “The underwriting standards on jumbo loans are still very strict. Compared to conforming loans, the risk of loss is lower.” Fratantoni’s assessment of the market was similar: “Jumbo borrowers have always had stronger credit than conforming borrowers, but today we see that average jumbo borrowers have credit scores of 800 compared to about 730 for conforming borrowers.”
Archana Pradhan, economist with CoreLogic, a global real estate data company, emphasized, “One reason for the gap is the increase of guarantee fees. That has the effect of raising rates on conforming loans. But Fannie and Freddie don’t guarantee jumbo mortgages, so jumbo rates aren’t affected by the guarantee fees.” Fannie and Freddie’s rising guarantee fees could be driving up interest rates on conforming mortgages faster than rates on jumbo mortgages. They charge guarantee fees to banks that sell conforming mortgages to them, and changes in the guarantee fees generally translate into higher interest rates for borrowers. Guarantee fees for conforming loans were first introduced in 2008 when jumbo mortgages were still more expensive than traditional mortgages. Between 2012 and 2016, guarantee fees on 30-year fixed rate mortgages rose from 0.38% to 0.61%.
How do banks set jumbo mortgage rates?
Since most lenders hold jumbo mortgages in their loan portfolios, the lenders can set rates using any standard they want. However, the methodology lenders use for setting jumbo rates differs very little from the methodology they use for setting conforming mortgage interest rates. Fratantoni explained, “Lenders look at the 10-year Treasury rate as a benchmark for a jumbo fixed-rate mortgage. They’ll also consider rates on conforming loans.”
To ensure they remain profitable, lenders add a spread to the 10-year Treasury yield to set jumbo mortgage rates. In general, the spread is between 1.5% and 2%. Lenders that lend to riskier jumbo mortgage borrowers will charge even higher interest rates to compensate for the increased risk of loss.
Lenders will consider the terms of the loan when setting jumbo mortgage rates. An adjustable-rate jumbo mortgage will have lower initial rates compared with a fixed-rate mortgage. It’s also possible for lenders to offer interest-only jumbo mortgages. These will generally carry higher interest rates.
Jumbo rates vs. conforming rates: How do they stack up?
Banks have limited options for selling jumbo mortgages, so they have to hold them in their portfolio. The limited ability to sell jumbo mortgages should drive interest rates up relative to conforming loans, but over the past four years that hasn’t been the case.
On the whole, interest rates on jumbo mortgages are still a little lower than rates on comparable conforming loans. This trend has held strong for the last five years, but it’s tough to explain exactly why. As previously mentioned, the stricter underwriting standards for jumbo mortgages may have driven the interest rates on jumbo mortgages down. The rising guarantee fees on conforming loans may also be a factor here. On top of that, it’s possible banks are using jumbo mortgages to woo wealthy people into becoming bank customers or to deepen customer relationships.
Whatever the reasons, jumbo mortgage rates are relatively affordable right now, and on average they are lower than rates on conforming loans.
What can we expect to see from jumbo mortgage rates in the future?
It’s impossible to say exactly where jumbo mortgage rates will go in the future. Kapfidze told LendingTree, “I think we would need a catalyst for another big change, and I don’t know what that catalyst could be.”
Despite the recent run-up, mortgage interest rates on jumbo and conforming products are still well below historical averages. If you’ve got a great credit score, and you want to buy a higher priced home, now could be the right time to take advantage of low rates on jumbo mortgages.