February 19, 2008
Savings From Increased Conforming Loan Limits Get Shaved
Remember that little comment we made a few weeks ago regarding increased prepayment risk associated with increasing conforming loan limits? From the Securities Industry and Financial Markets Association (SIFMA) on Friday:
Higher balance loans which are now temporarily eligible for Federal Housing Authority (FHA) and GSE guarantee programs under H.R. 5140, the Stimulus Package, will not be eligible for inclusion in TBA-eligible pools. They are instead expected to be securitized under unique pool codes for trading on a “specified pool” basis or inclusion in Real Estate Mortgage Investment Conduit (REMIC) transactions.
Thank increased prepayment risk for the unique pooling. And why does the pooling matter?
Jumbo mortgages now eligible for purchase by the nation's largest home loan finance companies [under the Stimulus Package] will be locked out of the market where trading helps lower rates to consumers...
Including jumbo loans in TBA pools would have had the unintended effect of raising rates on traditional conforming loans since investors assume they will receive the larger loans when they take delivery of the bonds, according to Freddie Mac. In TBA, the loans must be deemed fungible, so investors buy without knowing attributes.
In other words, hello "super conforming tier" and goodbye "conforming" mortgage rates for loans between $417,000 and $729,750 in San Francisco.
∙ Conforming Loan Limits: A Placeholder For Discussion And Analysis [SocketSite]
∙ SIFMA to Update MBS TBA Good Delivery Guidelines [SIFMA]
∙ Jumbo loans to be isolated from mortgage TBA: SIFMA [Reuters]
∙ If Lowering Rates Isn’t Working, Perhaps Increasing Limits Will [SocketSite]
First Published: February 19, 2008 1:22 PM
Comments from "Plugged In" Readers
can anyone out there decipher what the heck this means?
Posted by: cy at February 19, 2008 1:35 PM
so what does that mean?
Posted by: Mike at February 19, 2008 1:36 PM
Anyone else been noticing how much mortgage rates have headed UP in the last week or so? Not a good trend to keep the housing boom going.
Posted by: Mike B at February 19, 2008 1:41 PM
This alone pretty much assures that rates on these new "conforming-jumbo" loans will not be as low as on conforming loans (which have been increasing as of late). Beyond that, who knows when and if Fannie and Freddie will ever take on any significant share of these, which is the whole premise on which lower rates were assumed. This dies on December 31 (unless it gets extended). It will be a few weeks still before HUD comes out with its definitions of the new limits for each area. Then Fannie and Freddie will need to do extensive modifications of its IT systems to accommodate the changes, which, if it ever happens, will take several months at least. Then all the lenders will need to revamp their own IT systems to conform, which will take another few moths, at least. And note that Fannie and Freddie don't HAVE to take on any of these new "conforming-jumbos" -- they just CAN now. And they have pretty strict underwriting and LTV guidelines. If this ever benefits a single buyer, we're looking at 6 months from now or longer and very modest rate reductions. This one was not thought out too well.
Posted by: Trip at February 19, 2008 1:45 PM
Trip, you forgot to mention that when (if?) Fannie and Freddie are able to file their annual reports in March, it's likely they'll be showing rapidly escalating losses on their existing portfolios. We'll know in a month or so.
It'll be tough to convince end investors that they should now buy larger and riskier loans for a lower coupon, just because said loans got funneled through the GSEs, who may be skirting insolvency. And that's assuming the logistics you mentioned above have already been worked out.
Posted by: Dude at February 19, 2008 2:03 PM
Cy and Mike,
To understand this, you have to understand the current system. Conforming loans are sold to investors by Fannie Mae/Freddie Mac (FM/FM) who are basically insolvent, but guarantee the mortgages and charge a premium for doing so.
Jumbo loans (those above $417K) are sold to investors by investment banks, who have them insured by insolvent corporations, who charge a premium for doing so.
However jumbo loans are more likely to be refinanced because the value of refinancing is frequently greater than the transaction fees of doing so. As a result, if rates rise, the mortgage owner gets royally screwed because the rate of the jumbo may be fixed, or at least lower than prevailing rates. If rates fall, the mortgage owner doesn't make out on a jumbo (like they might on a lower value loan) because the homeowner will refinance. Heads I win, tails you lose.
So jumbo loans have had an additional premium built in to take into account for this problem that is uniquely theirs (transaction costs may be too high to refinance lower priced loans - the fees eat up the savings). The theory behind raising the loan limits was that, if you could just scramble the jumbos in with the lower sized loans, rates on the jumbos would fall because the pool of loans sold to investors would have less numbers of refinancings than jumbos alone.
Actually, this wasn't the theory at all. The theory really goes like this "I, your congressman, don't know or care why jumbos are more expensive, so it must be the insurance provided by insolvent FM/FM. If I tie jumbos to FM/FM, rates will magically drop, and who cares, the donations from the financial services organizations will skyrocket and I'll get reelected".
Instead of mixing the loans, FM/FM announced that they will keep the jumbos separate when being sold to the investors. This means that an investor who buys the loans will continue to have the interest rate risk as before, and will continue to have an insolvent company insuring the loans, so in all likelihood, rates won't really drop by much, if at all.
Now, FM/FM have this expectation, never stated by anyone, that if they fail to pay their obligations on the insurance they offer, the U.S. government would "step in", whatever that means.
With such a tenuous additional extra guarantee, perhaps the rates will be slightly lower if backed by insolvent FM/FM than they would if backed by any other insolvent insurer (none of whom will actually be able to pay when the time comes, they just collect the premiums and hand themselves fat bonuses until that day comes), but in the end, this puts us nearly back to where we were before.
And in the meantime, interest rates are rising, so Jumbos could be MORE expensive by the time the higher loans, if any, are sold by FM/FM. SO we could be further behind than when we started. Except for the campaign donations from the mortgage industry. Those will be way up.
Did I get any of this wrong?
Posted by: tipster at February 19, 2008 2:38 PM
If you look at local RE websites (their likely having no better understanding of any of this than the congressmen who passed it), they are proclaiming that with these changes mini-jumbo rates will now fall to the same level as conforming rates and "you will save $X each month" so it will soon be a great time to buy! Obviously, it won't work that way. But I wonder how many potential buyers might have been persuaded to sit out for now and wait until these new, low rates kick in?
Posted by: Trip at February 19, 2008 3:06 PM
I've had several emails from developments in SF. Here's an excerpt from the email I got from The Hayes. Truth in advertising?
"With the signing yesterday of the Economic Stimulus Act of 2008, President Bush helped usher in an unprecedented opportunity for home buying in the Bay Area. The stimulus package included legislation that temporarily raises the conforming loan limits through December 31, 2008 to $729,750 on Freddie Mac, Fannie Mae, and FHA-backed loans, effectively providing a shot in the arm to the real estate industry as a whole, and San Francisco in particular. This new higher limit on conforming loans positively impacts buyers shopping for homes at The Hayes in San Francisco's Hayes Valley."
Posted by: Amen Corner at February 19, 2008 3:15 PM
Count me in as one of those sideliners who has been putting off mortgage shopping due to this development.
Well, to be more specific, I was planning on looking in early 2009, but the carrot of a 'conforming' rate on a jumbo made me rethink waiting and trying to get in before Dec 31st. My plan was to shop in earnest around June/July or so.
Now, like many others I assume, I'm not sure exactly what to do....
Posted by: santacruzin at February 19, 2008 3:16 PM
"Now, like many others I assume, I'm not sure exactly what to do...."
IMHO, you shouldn't make a decision to buy based on rates, but rather based on price. You can always refinance your interest rate later, but once you pay a sales price, you're stuck with it.
Posted by: Foolio at February 19, 2008 3:29 PM
Foolio is absolutely right. These rate ploys are just marketing games.
Example: On a $700K mortgage at 7%, your monthly payment is $4,657. If rates fall to 6%, the payment is $4,196. That's a difference of $461 per month. Assume you live in the property for 5 years. That's a $461 monthly annuity for 5 years. If you can invest the difference at 4% in a savings account, the present value of that annuity is about $25K. So a 1% interest rate reduction saves you $25K in today's money over 5 years. Not bad, and definitely material.
However, compare that with the odds of the property you may buy declining by $25K or more during the next year or 2. We're already seeing foreclosures come to market at reductions of $100K+ in San Francisco. If your $700K loan is for 90%, you basicaly bought something for $780K. So a 3-4% price drop on your property in the near future wipes out any gain from the interest rate reduction (which may not even happen). And many of the new developments in town have already reduced prices by 3-5%.
For an analogy, think what'd you'd do if this wasn't San Francisco real estate, and it wasn't such an emotional decision. You wouldn't buy a Honda Accord for $40,000, would you? But what if the salesman came back and said, "Great news, we can finance that Accord at 6% instead of 7%, reducing your monthly payment from $792 to $773!" Would you buy now? I sure wouldn't. Especially when I could lease the same Accord for $350/month.
Posted by: Dude at February 19, 2008 4:00 PM
Yeah, I was pretty intent on buying by the end of this year, actually, if this plan went through. At this point, the supposed stimulus plan sounds like a total flop and will do/has done nothing to lower rates. Rates have been skyrocketing the past several weeks. The only ones benefiting from this are the banks. While it costs them much less to borrow now, the banks are trying to make up for their losses by refusing to lower consumer loan rates. Pfffft.
Posted by: S&S at February 19, 2008 4:00 PM
Who wants to bet that in an election year, somebody steps up and says "this isn't right! The consumers aren't benefiting from our legislation. I'm going to call a hearing and rake some bankers over the coals until they see the light. Rates need to go down for our people, not up!"
Posted by: Can't think of cool name at February 19, 2008 4:44 PM
Good description tipster.
this is not a surprise.
many here have hypothesized that mortgage rates may go UP not down with a drop in the Fed Funds Rate...
and many hypothesized that investors won't want to mix the "true" conforming with the new "minnie jumbo" comforming.
Only lord knows what will happen in the future with mortgage rates.
right now it's all about the RISK PREMIUM. mortgages are now seen to be risky. they've performed horrifially in the last year or so, with no sign of getting any better.
buying a mortgage backed security is like throwing your money away. so the mortgages have to offer a higher rate to compensate for the risk of loss of capital.
the govt will keep doing everything it can to sustain these unsustainable RE prices. I doubt they'll succeed, but I'm sure they'll cause quite the market distortion before they're done!
Posted by: ex SF-er at February 19, 2008 4:45 PM
Even if it is ultimately a "super conforming jumbo", it can't be any worse than the current spread between jumbo and conforming. I'll gladly take some middle ground between the two. Cutting the spread in half would shave half a point off of "SF conforming jumbos"...
All the advice above would be worth something if you could see into the future and KNOW exactly what rates and/or prices will do. (If you know exactly what the stock market will do six months in advance, you can also make some great investment decisions...)
For those who suggest that you can always refinance at some point in the future and that "rate ploys are marketing games" (not sure what that means), you need to remember that we are already sitting around near historic lows. There are plenty who think inflation/stagflation is coming our way ala the seventies. Your parents might recall buying a house with an 18% mortgage.
Posted by: "Dave" at February 19, 2008 5:10 PM
it can't be any worse than the current spread between jumbo and conforming
not necessarily true... but regardless who cares about the spread? most people would rather have a lower overall interest rate.
would you rather have:
jumbo loan at 7% and comforming at 6% (1% spread)
jumbo loan at 8.5%, "jumbo conforming" at 8%, and conforming at 7.5% (0.5% spread)
It would be nice if one could use rational analysis and come up with a reasonable estimate of future interest rates.
but there is so much tinkering going on now (govt programs and intervention, Fed rate policy, etc) that this is an impossibility.
oh well, it'll be fun to watch. I'm sitting this all OUT.
Posted by: ex SF-er at February 19, 2008 7:21 PM
C'mon exSfer, Dave's use of the word "spread" obviously implied the current conforming rate was a constant.
Total agreement with Dave. Who cares that the mini-jumbo rate will still be higher than the confirming rate, as long as the rate is *lower* than it would be otherwise. This seems pretty plain.
Posted by: pwb at February 19, 2008 8:06 PM
"Economic Stimulus" is pure Marketing and PR. Like "Social Security", it is also a joke--a bad, expensive, tax-payer funded joke.
Plus, it's an election year, and the theives inside the Beltway want you to know that they "care".
Have you ever wondered how some of these folks can come from average means, get elected to Congress and in 6 - 12 years they are millionaires on appx $150K / year?
Regardless of the words coming out of their mouths or the press releases coming from their PC's...these bandits are Citizens of Washington D.C. first and foremost with a primary goal of maintaining that citizenship.
Posted by: Rich at February 19, 2008 8:11 PM
Another way to get at the same answer might be the following:
The current, pre-stimulus package limit for conforming loans is higher in 2 locations. It is $625,500 in AK and HI. So there's been conceivably a lot of experience in evaluating the risk premium between a $417k typical conforming loan, and the top limit in these two markets. According to much of the conversation above, there should be a difference with these loans.
So, how are the conforming loans between $417-625.5k traded? Are they separated from regular conforming loans? If not, how much of a difference in rate is there? According to Wells Fargo's rates today, there's no difference at all. Is there a reduced market risk in this two markets which would make up for the increased default risk? I think we are only getting part of the picture.
My reaction is that currently they don't know how to price the risk of these "super conforming loans" so they'll set them aside and throw a date until the credit markets feel comfortable with the instrument and that risk is being appropriately evaluated and priced.
Posted by: Dede at February 19, 2008 9:08 PM
My reaction is that currently they don't know how to price the risk of these "super conforming loans" so they'll set them aside and throw a ....dart,,,, until the credit markets feel comfortable with the instrument and that risk is being appropriately evaluated and priced.
Posted by: Dede at February 19, 2008 9:10 PM
"C'mon exSfer, Dave's use of the word "spread" obviously implied the current conforming rate was a constant."
Yes, I know, and it's an assumption that should not be made (that the current conforming rate will be constant). mortgage rates rarely if ever remain constant.
"Total agreement with Dave. Who cares that the mini-jumbo rate will still be higher than the confirming rate, as long as the rate is *lower* than it would be otherwise"
No, you are agreeing with me. This was my point. as I said
"not necessarily true... but regardless who cares about the spread? most people would rather have a lower overall interest rate."
Posted by: ex SF-er at February 20, 2008 6:20 AM
How does this affect people who took out 2nd loans? Does this help them by allowing them to refi into one loan?
Posted by: natomahead at February 20, 2008 12:19 PM
2nd loan? SF is different. Nobody here has a second loan. SF is full of Google millionaires. What are you thinking?
So much fun on the Titanic these days!
Posted by: anon at February 20, 2008 1:05 PM
natomahead, I can't really tell if you could be helped by this without more info. It depends on the size and rates on your two current loans. If both your first and second loans together come within the new conforming limits, but did not previously, then yes, it is possible you could benefit by refinancing into a single jumbo-conforming loan. But read above -- it is not likely that the rates on loans between $417-729k will be substantially different because of this change.
Posted by: Trip at February 20, 2008 1:24 PM