Banks' Pursuit of Top-Tier Borrowers Drives Jumbo Rates Down
Competition among banks for the mortgage business of wealthy consumers is driving down interest rates on jumbo mortgages to the point that they're lower than conforming loan products.
Increased regulatory requirements are driving origination costs up, and in turn, lowering profits so much that originating mortgages has become a losing venture for many originators. By competing for more affluent consumers, banks can boost their bottom lines and target these borrowers for other financial products, key factors in the interest rate declines for jumbo loans.
At the end of June, there was just a two-basis-point difference between rates on conforming mortgages and rates on originations over $417,000. But in the weeks since, the jumbo rates have moved lower (down 21 basis points between the weeks of June 13 and July 18), while interest rates on conforming mortgages have for the past three weeks been in the area of 4.32% to 4.33%, according to the Mortgage Bankers Association.
The competition in the jumbo lending arena has grown fivefold to sixfold in the past year, said Malcolm Hollensteiner, director of retail lending products and services at TD Bank in Cherry Hill, N.J. "Everyone is back in the market with jumbo products and they're all competitively priced. The competition for jumbo loans today has never been fiercer."
Part of the attraction for originators to enter the jumbo market is that the product can have a lower return than a conforming loan, but the lender can make just as much money or more, he pointed out.
Lenders are more competitive in the jumbo market because they can be, said Keith Gumbinger, a vice president at HSH.com. The vast majority of jumbos being written are for the lender's own portfolio.
"That gives the lender tremendous flexibility on pricing," he said, adding that while lenders aren't pricing loans so low that they're losing money, originators know they have to remain competitive in the marketplace.
Still, banks are willing to give up some of the returns on a jumbo mortgage to get their foot in the door and build a deeper relationship with wealthy borrowers.
"They obviously like the jumbo demographic borrower because of the possibility the bank will have a shot of additional relationships with that consumer, especially on the wealth management and asset management side," said Hollensteiner.
Originators are not widening the credit standards for jumbo loans, and Hollensteiner thinks the opposite is true. If the underwriting on jumbo loans was getting looser, their pricing would not be as aggressive as it is right now. "I don't think any lender today can afford to loosen their credit guidelines while reducing their pricing margins," he said.
On the secondary market, jumbo loan rates are closer to rate of the 10-year Treasury than conforming loan rates are, said New York-based Brean Capital's head of fixed income strategy, Scott Buchta.
Because they keep jumbo loans in portfolio, banks have lowered jumbo rates like they do other lending products they also hold on their balance sheet, he said. The incentive to lower rates on conforming mortgages is absent because those loans are sold on the secondary market.
However, this secondary market pricing difference is not the same reason why banks were pricing jumbo loans lower than conforming mortgages at the end of 2013, when rates were on the rise.
Then, banks had mark-to-market risk and needed to counter the exposure they elected to take on by increasing the size of their lending portfolios. So they sought higher-quality jumbo loans on their balance sheets, especially adjustable-rate products that matched their asset-liability duration risk, Buchta said.
Brent Nyitray, director of capital markets at iServe Residential Lending in Stamford, Conn., also thinks banks are willing to give up returns on jumbos in exchange for building borrower relationships. But the current climate in the housing market is another factor, he said.
The higher end of the home sales market is the most active right now, which means buyers need larger loans. The growing competition among lenders for their business is driving jumbo rates down.
It's the home builders like Toll Brothers that serve high-end consumers that are doing well financially this year. "The average square foot of a new home is 140 square feet bigger than it was during the peak" of the housing boom, Nyitray said.
As for why conforming rates are relatively unchanged in recent weeks, observers again point to the housing market as a contributing factor. The first-time homebuyer market, whose customers typically rely on both government-backed and conforming mortgage products, has been "underrepresented" in the housing recovery, said Hollensteiner.
While the first-time homebuyer segment has started to pick up in recent months, consumers are still struggling with a weak job market and high student loan debt loads, Nyitray said. Since they're not buying homes, lenders have to compete for the higher end borrowers who are in the market.
Conforming loan pipelines are smaller today since the start of the post-bust period but refinance activity could get a jolt if rates were to drop by 12.5 basis points, Buchta said.
The MBA gathers and reports its rate data differently than HSH.com, as the Riverdale, N.J.-based consumer finance research firm doesn't include conforming jumbo loans in its definition of jumbo, and thus has a tighter spread between rates on conforming and jumbo products. The MBA also uses a simple average to calculate rates, rather than a weighted average that other researchers use.
"Mortgage rates continue to hang around low levels, but for every bright spot of economic news, there seems to be a countervailing force on rates, keeping them down," Gumbinger said about the overall interest rate climate. "Better news on jobs, housing and a recent pattern of solid growth are being offset by troubles in the Middle East and Ukraine, giving investors ample reason to stash cash in the safety of U.S. markets."
Borrowers seeking jumbo loans are high credit quality borrowers, with credit scores of 760 or greater, plus they typically have down payments of 20% or more.
Meanwhile, conforming borrowers are coming to lenders with lower credit scores and smaller down payments, making them subject to loan-level pricing adjustments by Fannie Mae and Freddie Mac—a difference in credit quality that may be keeping conforming rates more steady than jumbos, Gumbinger said.
If anything, the cost of a conforming loan has risen in the last couple of years with the increase in guarantee fees and loan-level pricing adjustments. Thus, the cost to originate a conforming loan has risen, equal to or above the cost of doing a jumbo loan, even while the cost to originate a jumbo loan hasn't declined, he added.