The Future of Jumbo Mortgages

by Tom Tousignant

in Blog, Home Buying, Mortgages, Refinancing

What is it going to take to improve rates on jumbo mortgages in Charlotte? You may be surprised to know that the solution isn’t really in the hands of banks or the Federal Reserve. It depends on how these mortgages are securitized and on Bond Investors appetite for risk / returns.

Mortgage Backed Security
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Today, 95% of mortgages are guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae. Since jumbos don’t conform to these agencies’ criteria, they expose investors to more risk.

This has dampened the market for jumbo mortgages, which means lenders must lend their own money and then keep the loan on their own balance sheet. To avoid tying up capital that could be used to make more mortgages, lenders are creating more stringent lending guidelines and restricts how many loans they will approve.  (Funny how things change when it is their money, and they can’t jsut transfer the risk to someone else!)

If lenders could package and sell more jumbo mortgages as securities, we would see better rates, and borrowers would benefit. What would it take to make this happen?

The flaw in jumbo securitization now
Currently, a pool of, say, $100 million of jumbo mortgages may be split into $95 million of highly-rated (and theoretically low-risk) AAA bonds and $5 million worth of subordinate bonds that act as credit support for the AAAs. If any of the underlying mortgages default, the subordinate bonds absorb the losses before the AAAs lose a penny.

This structure opened a whole new universe for investors who were limited by regulation or investment charters to buying only AAA-rated securities, while allowing investors with more risk appetite to buy the higher-yielding subordinate bonds. The banking, mortgage, and housing industries were transformed by the enormous new source of capital achieved with very high efficiency. But there was a fly in the ointment.

Securitization agreements attempt to consider all the possible environments a security is likely to encounter, and spell out exactly what happens under those circumstances. However, they’re typically based on what happened in the past, and historical extremes may be omitted on the assumption that “things are different now.” As a result, they struggled to adapt when confronted with the “100-year floods” we’ve experienced lately — conditions that were unimaginable to the sellers.

Is there a better way?
An ideal method of efficiently attracting capital to fund jumbo mortgages would:

  • Separate the various risk levels of a mortgage’s capital structure, so those parts can be sold to buyers who will pay the best price
  • Be able to adapt to changing credit environments
  • Allow the seller (The bank that did the loan originally) to retain a reasonable amount of the risk (to align their interests with the buyer’s) but also clearly pass control of the loans to the buyer

(This last point is more important than it may sound. Under new accounting rules, a seller who retains too much control over, or risk from, a securitization is required to consolidate the transaction back on its balance sheet. Unfortunately, this will make lenders more wary of securitizing jumbo loans.)

One possible solution might be a jumbo securitization structure that combines standard AAA bonds with credit enhancement modeled on that of mortgage insurance companies or some REITs, which have been able to actively manage their exposure, adjust their policies, and use earnings from new business to help replenish capital as conditions warrant. The result could be something even more liquid and more sustainable than traditional securitizations.

For now at least, the supply of jumbo mortgages seems to be lower than demand. But that could change in 2010 if stabilization of home prices leads to more jumbo lending.

Another thing to look for is lower demand for conventional loans – if fewer FNMA conforming bonds were being offered, yield-hungry investors might look into nonconforming mortgage securities.  more buyers of non-conforming securities would bid up the prices, resulting in lower yields and lower interest rates to home buyers.

What can you do right now?

If you need a Jumbo Mortgage (Above $417,000), you do have a few options:

  • Combine a First and Second Mortgage to get the amount of money you need.  You will still need 10-15% equity in the house.
  • Put down more money  – borrowers with more equity are effectively sharing the risk with the lender, so bigger down payments can really reduce interest rates.
  • Have the Seller pay Point to ‘Buy down the Rate’.  Most lenders allow the Seller to pay up to 6 Points (6% of the loan amount) toward the buyers’ closing costs.  By using several points to pre-pay the interest, you can get a Jumbo loan with a lower rate than a conforming loan.  Ask your mortgage professional to explain more about this strategy, or give me a call to find out more.
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