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Bad news for jumbo mortgage loans

NORTH PALM BEACH, Fla. – Aug. 13, 2007 – Buyers of pricey houses are finding that money has suddenly become more expensive to borrow. Ditto for loan applicants who don’t want to prove that they told the truth about their incomes.

Rates on jumbo and Alt-A mortgages have zoomed upward since the last week of July, even as rates on conforming, fixed-rate mortgages slipped downward.

The development is bad news for people who want to borrow more than $417,000 to buy a house or refinance a loan, or who can’t or don’t want to document their income. Rising jumbo rates make it more difficult to sell a house costing half a million dollars or more.

Conforming mortgages are home loans that meet guidelines set by Fannie Mae and Freddie Mac. Among other things, those guidelines set a maximum loan size, called the conforming limit, which changes annually. In 2007, the conforming limit is $417,000. A jumbo mortgage is a loan for more than the conforming limit.

The conforming guidelines also call for borrowers to document their income, or at least to be prepared to do so. Stated-income loans, in which the borrower doesn’t document his or her declared income, fall into a mortgage category called Alt-A. Other types of loans, such as option adjustable rate mortgages, or ARMs, are considered Alt-A, too.

A loan can fit into both categories – to be both a jumbo and an Alt-A. It’s a common combination in Southern California, where prices are high and option ARMs are popular.

In Bankrate’s weekly rate surveys, the average 30-year fixed jumbo rose about a third of a percentage point in two weeks, to 7.35 percent on August 8. Meanwhile, the average 30-year fixed conforming loan fell almost a tenth of a percentage point, to 6.66 percent.

Climbing jumbo effect

Jumbo rates climbed quickly. Late last week, Wells Fargo raised the rate on its jumbo 30-year fixed by more than a percentage point – snap, just like that. Other lenders didn’t hike so dramatically, but rates did rise, both for fixed-rate and the more popular adjustable-rate jumbo mortgages.

“I’ve never seen anything like this in my life,” says Bob Moulton, president of Americana Mortgage Group of Manhasset, N.Y. “The last couple of days last week, it was difficult to place loans.”

Moulton quoted one client a 7 percent rate on a stated-income, jumbo mortgage. That was on a Monday. By Thursday, the rate had jumped to 13 percent and the client was considering an option ARM, which would allow him to pay interest only or even less than the interest accumulated over the month. It’s either that or lose a $120,000 deposit.

How did this happen?

To understand why jumbo and Alt-A rates climbed so fast, you have to know a little bit about how the secondary mortgage market works.

Many mortgages are sold to investment banks, which bundle them into pools of thousands of home loans. Investors buy bonds that entitle them to a share of the principal and interest that homeowners pay every month. The prices and yields of these bonds can vary.

Bond prices and yields vary depending on:

• The average interest rate of the loans in the pool.

• The odds of the loans being paid off early (high-interest loans are likely to be refinanced more quickly, removing those loans from the pool).

• The credit risk involved. Certain borrowers impart more risk to the bond holders who own a share of their loan payments. Among those risky borrowers: people with flawed credit, homeowners who are up to their eyeballs in debt and applicants who don’t document their incomes.

The jumbo loan market has frozen up because of uncertainty regarding that third bullet point. When jumbo mortgages are securitized, the loan pools contain a mixture of mortgages in which borrowers documented their incomes along with mortgages in which borrowers merely stated their incomes, without providing documentation. In other words, they mingle jumbo and Alt-A.

Many – probably a majority – of stated-income borrowers exaggerated their earnings so they could qualify for a loan. As a consequence, a lot of them got mortgages that they couldn’t afford in the long run. Investors now believe that stated-income borrowers are going to default on their jumbo loans in bigger than previously expected numbers. So they have virtually stopped buying Alt-A and especially jumbo Alt-A mortgages. When lenders can’t sell the loans, they stop offering them to borrowers – or they ration them by jacking up the rates. That’s what happened.

Who wins, who loses?

Who wins: People who buy homes months or years from now, as house values decline.

Who loses: People who want to borrow more than $417,000, or who don’t want to document their income. Sellers of expensive houses, especially in pricey markets such as Southern California.

Strategies for homebuyers

There are some workarounds. Making a down payment of at least 20 percent helps. So does documenting one’s income, although that forces borrowers to tell the truth about how much they make – which limits the amount that they may borrow. Another strategy is to get a piggyback loan: Instead of borrowing $500,000, a home buyer can get a first mortgage for $417,000, and a fixed-rate home equity loan for $83,000. Not every lender might go for a loan structured like that, though.

Another tactic is to shop for a less expensive house. Pat Lashinsky, CEO of ZipRealty, believes this already is happening. It can happen like this: A family that planned to buy a $600,000 house with a $120,000 down payment would have to get a jumbo mortgage of $480,000; that family might decide to buy a $500,000 house instead, so they could get a conforming loan at a lower rate.

Affect of falling demand

Falling demand for expensive houses could lead values to fall. Rising rates eventually could lead to more foreclosures, which would add to the supply of similar-priced houses, sending their values lower, creating a vicious circle of falling prices and rising foreclosures.

“I’m a little concerned about that as well,” says Larry Goldstone, CEO of Thornburg Mortgage, a Santa Fe-based lender that specializes in ARMs, usually for jumbo customers. “Credit is tightening very quickly.”

Goldstone is waiting to see if there’s solid evidence that demand for expensive houses is dropping. In the absence of such evidence, he thinks the rhetoric is getting overheated. When he hears words like “debacle” and “correction” used to describe mortgage and housing markets, he says: “I don’t know that those words are real good descriptors.” Investors who buy mortgages are nervous, and they need some confidence, he says, and the Federal Reserve could help by acknowledging the problem.

Tom Davie, owner of Davie Mortgage Group in Palm Bay, Fla., says the housing market isn’t collapsing. It just seems that way because some markets boomed so much in the past few years. “It’s just going back to normal,” he says. Prices would stop falling if people would stop putting their houses on the market, he says.

That’s easier said than done. Everyone who tries to sell a house has a good reason to do it. Anyway, there is one group of people who might benefit if lack of availability of jumbo mortgages causes house prices to fall: First-time buyers in expensive markets, especially Southern California, where even a modest cottage pushes most borrowers into jumbo territory.

© 2007 Bankrate.com, Bankrate Inc. All rights reserved.

Reins kept on Fannie, Freddie

WASHINGTON – Aug. 13, 2007 – A government agency refused to loosen restraints on Fannie Mae and Freddie Mac so they could play a larger role in the troubled mortgage markets.

The companies, which were created by the government to provide funding for home loans, had argued that they could help struggling lenders and borrowers if regulators allowed them to buy more mortgages and mortgage-related investments.

But the Office of Federal Housing Enterprise Oversight said that Fannie Mae and Freddie Mac can pick up slack in the markets by more efficient means – packaging mortgages into securities for sale to other investors. The agency cast doubt on the potential benefits of letting the companies buy more, saying that the prime segment of the market in which they operate is generally free of trouble.

The agency added that it was still concerned about the safety and soundness of the companies, which remain unable to issue timely financial statements years after accounting scandals exposed weaknesses in their internal controls. Those concerns are what inspired the agency to negotiate the caps on the companies’ investments last year, OFHEO said.

OFHEO “will keep under active consideration requests for an increase in the portfolio caps, but we are not authorizing any significant changes at this time,” James B. Lockhart III, the agency’s director, said in a news release.

Lockhart said the agency was exploring ways for the companies to “enhance their support for affordable housing,” but he didn’t say what that might involve.

The companies’ stocks have shot up over the past week based on perceptions that they stand to benefit from the mortgage industry’s woes and on anticipation that OFHEO would lift the caps. The stocks continued to climb even after President Bush threw cold water on the notion of raising the caps in comments earlier this week.

OFHEO, which isn’t required to follow the president’s lead, announced its decision Friday after the markets had closed.

For Fannie Mae and Freddie Mac, the battle wasn’t a total loss. On the field of public relations, they were able to cast themselves as willing to ride to the rescue while their nemeses in the government stood in the way.

Early yesterday, Fannie Mae chief executive Daniel H. Mudd issued a statement arguing that raising the company’s investment cap by 10 percent “would help to alleviate the ongoing credit crunch … and bring an additional measure of stability.” On Thursday, Mudd went on television to deliver a similar message.

For years, politicians and regulators have accused the companies of doing little for the public benefit while using their federally chartered status to the advantage of their shareholders and executives. Meanwhile, the Federal Reserve has declared that the companies have gotten so big that they could pose a risk to the financial system. Together, they hold or guarantee 40 percent of the mortgages in the United States, according to OFHEO.

That agency has been a persistent critic, issuing reports on alleged accounting manipulations and joining the Bush administration in demanding tighter regulation of the companies than many in Congress have been willing to support.

Analysts generally agreed that allowing Fannie Mae and Freddie Mac to increase their investments would boost their profits. Leaving a cap on their investments could prevent them from seizing a rare opportunity to buy huge volumes of assets at fire-sale prices.

But there was disagreement and uncertainty as to who else would benefit from a lifting of the caps.

“We want to know how that would be linked to keeping people in their homes,” said Allen Fishbein, the Consumer Federation of America’s director of housing and credit policy. “I don’t think I’ve seen enough information to determine how that would work.”

In an appearance on the financial cable channel CNBC on Thursday, Mudd said Fannie Mae would use added buying power to help people trying to finance apartment buildings and credit-worthy borrowers who are locked in subprime loans. Mudd noted that the company was prohibited from funding mortgages of more than $417,000, known as jumbo mortgages, and he said it would take an act of Congress to change that.

Much of the pressure to raise the investment caps was coming from Wall Street, and some observers said giving Fannie Mae and Freddie Mac a freer hand would primarily benefit institutional investors such as hedge funds holding assets that have plunged in value.

Bailing out investors could enable them to pump more cash into the mortgage market, but it wouldn’t obligate them to do so.

“Buying more of the distressed subprime or Alt-A [unconventional mortgage] securities tilts more toward a lift for Wall Street balance sheets than toward subprime borrowers,” Steven Abrahams, a senior managing director at Bear Stearns, said in a report this week.

Fannie Mae and Freddie Mac “have the means to make meaningful purchases without breaching their portfolio limits,” analysts at Bank of America said yesterday in a report to clients.

Some troubled lenders were looking to Fannie Mae and Freddie Mac for relief. But others in the financial services industry opposed strengthening the companies’ hands.

“Calls to extend the reach and authority of Fannie Mae and Freddie Mac into the healthy and functioning primary mortgage market provided by community lenders appear unjustified,” Alfred A. DelliBovi, president of the Federal Home Loan Bank of New York, said in a letter to OFHEO.

Since the companies were found to have misstated their finances by billions of dollars, policymakers generally have agreed that the regulators need more power, but they have argued to a stalemate over details.

Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, said in an interview this week that the debate over Fannie Mae and Freddie Mac was largely ideological, dividing policymakers who believe the companies have an important role to play in support of housing from others who believe government-sponsored enterprises have no place in the private market.

The upheaval in the financial markets over the past week may have altered the debate, giving new urgency to the legislation – and additional focus to the potential good Fannie Mae and Freddie Mac can do, some observers said.

Friday, Senate Banking Committee Chairman Christopher J. Dodd (D-Conn.) reaffirmed his view that regulators could safely ease the caps. “The Administration can’t continue to close their eyes to the scope of the problem and hope it goes away,” he said in a statement.

Copyright © 2007 washingtonpost.com, David S. Hilzenrath