‘Conforming mortgages’ are loans suitable for purchase by Fannie Mae and Freddie Mac. To be eligible for purchase, such loans must meet certain standards – such as how the loan is documented and the down payment amount. One of the most important standards is the maximum loan size for a single-family home – the most that can be borrowed and still qualify for sale in the secondary market.
Higher loan limits have traditionally made the purchase of expensive homes easier because borrowers could more readily finance a transaction. Where the loan limit does not fully reflect local housing costs, home sales are held down. In high-cost areas – think of major metro centers along both coasts as examples – the lack of financing for more expensive homes has been a substantial problem. In San Francisco, the typical home sold for $1,348,480 in April, while the conforming loan limit for the city – a high-cost area – is currently $625,500.
In the past, the financing solution for more expensive homes was extra cash from the buyer on top of a conforming loan, the use of a second loan, an all-cash transaction, seller financing, or the use of a ‘jumbo’ mortgage.
Jumbo Mortgages And Banking Relationships
Traditionally, jumbo mortgages have not been an enticing choice for borrowers because they were more expensive than conforming mortgages. Also, as a practical matter, they were often difficult for borrowers to obtain.
‘Very often, retail banks offer jumbo loans primarily to high net-worth individuals,’ says Rick Sharga, executive vice president at Auction.com. ‘The loan was to cement a relationship with the client as part of a package that included such things as business banking, personal loans, checking accounts and other financial services.’
With housing prices coming back in most markets, the government is now considering a higher loan limit for conforming loans. More liberal loan limits will help buyers in high-cost markets, meaning they will also make expensive homes more salable – good news for owners, brokers and lenders.
The Federal Housing Finance Agency, regulator of Fannie Mae and Freddie Mac, is now looking at ways to raise the conforming loan limits because real estate prices around the country have almost returned to 2007 peak values.
The reason to favor higher loan limits in the past was that jumbo loans were a higher-priced, premium mortgage product. That was then, but as of this writing, prices are upside down: You're likely to get jumbo loans for roughly 0.25% less than conforming mortgages.
How did this happen? The answer has to do with the cost of creating conforming loans.
The World Of G-Fees
When lenders sell a conforming loan to Fannie Mae or Freddie Mac, there are a number of costs involved, including what are known as ‘guarantee fees’ (g-fees).
Back in 2001, g-fees were 19 basis points – a ‘basis point’ is one hundredth of 1% – but after the mortgage meltdown, g-fees began to be seen as a way to raise money for Fannie Mae and Freddie Mac so they could repay bailout money loaned to them by the government.
Congress also saw a moneymaking opportunity with Fannie Mae and Freddie Mac and created Section 402 of the Temporary Payroll Tax Cut Continuation Act of 2011. This legislation added a temporary fee of 10 basis points for mortgage borrowers, money – according to the National Association of Realtors – that was used to fund such federal costs as ‘a two-month extension of the payroll tax cut, unemployment benefits and Medicare reimbursements.’ The money collected in 2011 was no more than a ‘stealth’ federal tax charged to mortgage borrowers – costs that had nothing to do with homeownership or real estate financing.
By 2012, g-fees reached 38 basis points.
Even at 38 basis points, g-fees may seem tiny – but they add up. As Andrew Bon Salle, senior vice president of Fannie Mae, wrote in 2012, ‘Borrowers with 30-year, fixed-rate mortgages near the current conforming loan limit of $417,000 can expect to pay more than $8,500 over the life of the loan to fund the 10 basis point fee.’
You can imagine the full cost when g-fees are almost four times larger.
Jumbo mortgages are not sold to Fannie Mae and Freddie Mac because by definition they simply don't meet conforming loan standards – they're above the loan limits. Because jumbo loans cannot be purchased by Fannie Mae and Freddie Mac, the result is that, without g-fees, lenders can charge less interest than the rate they require from conforming loan borrowers.
A lot of people have begun to catch onto the thought that although higher loan limits used to be a big thing, that's no longer the case. Now it's cheaper to get a jumbo loan because such financing is no longer reserved exclusively for elite bank customers. Today, almost 20% of all loans are jumbos – evidence that mortgage loan limits may be a worry of the past.
Peter G. Miller is a nationally syndicated real estate columnist. His books, published originally by Harper & Row, sold more than 300,000 copies. He blogs at OurBroker.com and contributes to such leading sites as RealtyTrac.com, the Huffington Post and Auction.com. Miller has also spoken before such groups as the National Association of Realtors and the Association of Real Estate License Law Officials.
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