Magazine article Economic Trends

Jumbo Mortgages and Mortgage Market Conditions

Magazine article Economic Trends

Jumbo Mortgages and Mortgage Market Conditions

Article excerpt

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Mortgage markets can have a big effect on the economy more generally, as recent turmoil in financial markets--which began with turbulence in the mortgage industry--affirms. Conditions in mortgage markets are therefore followed closely. One interesting indicator of mortgage market conditions is the interest rate spread on jumbo mortgages.

Jumbo mortgages are loans too big to be purchased by Fannie Mae and Freddie Mac, the two largest secondary market lenders (together, they own or securitize more than 70 percent of the residential mortgage loans in the United States). Fannie and Freddie are permitted to buy only those loans that conform to a limit set by the Office of Housing Enterprise Oversight--$417,000 for the continental United States since 2006 (higher for remaining states and territories). Loans above the conforming limits are usually purchased by financial institutions ranging from commercial banks to hedge funds, as well as Wall Street conduits that provide warehouse financing for mortgage lenders.

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Jumbo mortgage loans pose a higher risk for lenders, and this risk is consistently reflected in the spread between the interest rates on jumbo mortgages and conventional mortgages, where the historical average is about 30 basis points. The risk reflected in this long-term average arises because it is harder to sell a luxury residence quickly for full price in the event of default. More generally, luxury homes are harder to price, and their prices are more vulnerable to market highs and lows; as a result, prices are more difficult to forecast. An increase in the volatility of housing prices could also increase the perceived risk associated with jumbo loans and hence, the spread.

However, the spread between jumbo and conventional mortgage rates is affected by more than just the different sort of homes that belong to the jumbo pool. Interest rates on jumbo mortgages also reflect changes in the liquidity of the secondary market and the willingness of investors to buy its securities. Because Fannie Mae and Freddie Mac don't buy nonconforming loans, the secondary market for jumbo mortgages is generally less liquid than for conventional mortgages. …

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