Supersize my loan! Jumbo loan use is up

The spread between average jumbo loan rates and 30-year fixed rate mortgage (FRM) rates is the smallest in five years.

Jumbo loans are defined as loans over $417,000 or up to $625,500 in some high-price markets.

Nationally, jumbo loans were only 0.18 percentage points higher than 30-year FRMs on August 9^th. Historically, jumbo loans tend to be 0.25 points higher than 30-year FRMs.

It appears more homebuyers are benefitting from low jumbo rates. Jumbo use rose by 20% from Q1 to Q2 of 2013.

As home prices continue to rise during this mini-bubble, jumbo loans are becoming the only way for some homebuyers to get the home (and location) they want.

Similarly, lenders are also more inclined to grant jumbo loans as their balance sheets continue to heal from the long recession and drawn out recovery.

Still, qualifying for a jumbo isn’t easy. A homebuyer needs:

at least a 20% down payment;
a credit score of 720-780 to qualify for the best jumbo rates; and
9-36 months of mortgage payments in reserves (compared to two months of reserves for most conventional FRM loans).

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In California, jumbo use has also accelerated over the past year. This is particularly true in the Bay Area, where jumbos made up more than half – 51% — of all home sales in July 2013. In Southern California, jumbos accounted for 28% of home sales.

Jumbo loan thresholds are at the high end of the spectrum ($625,000) in much of California, including the Bay Area, Los Angeles and Orange County.

In June, jumbo-use was higher in California than at any other time since August 2007.

Related article:
July home sales jump

One might assume that an increased use of jumbos is indicative of a recovering housing market.

Not so fast.

The rise in jumbo use is only an indication of unstable speculator activity. A similar reflection of market instability is the rising use of adjustable rate mortgages (ARMs). ARMs artificially extend the borrowing reach of homebuyers, pushing many beyond a sustainable level when interest rates adjust upward. Thus, ARMs carry a more serious risk of default than fixed rate mortgages (FRMs) since interest rates can only rise going forward, pushing payments higher.

Appraisers have obviously accommodated lenders by reaching the “jumbo” number needed to justify these loan amounts. As a result of this complicit activity, prices have risen dramatically beyond the rate of increases in personal income and consumer inflation – and comparable sales.

Strangely, hyper-activity from speculators, which began mid-2012, has yet to cease.

Cash-hungry speculators have single-handedly fueled a steep rise in home prices across all tiers, but particularly among low-tier sales. In fact, low-tier home prices are 27% higher than one year ago and high-tier prices are 17% higher as of May 2013, as reported by the Case-Shiller pricing index.

What does low-tier speculation have to do with jumbo loans? This pricing activity has pushed more home sales from the low-tier into the mid-tier, and in turn, mid-tier homes have been forced into the high tier, where jumbos are necessary. Think of the escalating waterline of a rising tide.

You are today staring a momentum market directly in the face, and its exhaustion is rapidly approaching.

Thus, end users caught up in the momentum will find themselves having over-financed what is essentially a mid-tier property with a jumbo loan. This is a recipe for more negative equity to come when the frenzy dies down and the 2013 bubble deflates, as bubbles always do. Further, the ARMs aspect of jumbos only worsens conditions going forward.

However, today’s high level of jumbo-use will subside. Mortgage rates will continue to rise, and that will cut into this bubble. Further, today’s low personal savings rate means few homebuyers have the required 20% down payment (or enough in reserves) to qualify for jumbo loans.

The home price jump experienced in 2012-2013 that fueled the crossover into high-tier properties requiring jumbos is near its end. Prices have been supported entirely by speculators, and lack the needed end user base to stay at these heights.

Speculator acquisitions are fast piling up and creating a second “shadow inventory” that will return to the market to be sold to end users who are in short supply. It’s not only lenders who are returning properties to the MLS inventories, but soon investors will as well by design.

While agents will not tell end user buyers to wait out this crowded marketplace, the end user homebuyer is better off waiting for the price surge to subside than take out a jumbo loan on a home that did not require one before the price jump. Tell your buyers they don’t have to wait long. Prices will level off and likely begin dropping by 2014, preceded by the decline in jumbo loans in Q4 2013.