February 13, 2011

The Future of Mortgage Lending, Part 1

February 13, 2011

The Future of Mortgage Lending, Part 1

In the coming weeks, we’ll be doing a series on Jumbo mortgages. And don’t let the terminology fool you. Today jumbo mortgages are for loans above max government-backed caps of $729,750. But as the politicians begin plans to wind down government support, their first big step will be to reducing government-backed loan caps.

So a ‘jumbo’ will become smaller and smaller. Therefore it’s critical for consumers to know the new lay of the land. And so we begin…

The government—via Fannie Mae, Freddie Mac, and FHA—has controlled the overwhelming majority of the home lending market since the credit crisis began in July 2007. They buy and/or insure loans from lenders up to $729,750. This means less risk for lenders, which translates into lower rates for borrowers.

For “Jumbo” loans higher than $729,750, there have been no options for lenders to bulk sell (or securitize) their loans since July 2007. In fact, a $222 million jumbo mortgage bond offering by Citigroup last May was the only jumbo securitization during the entire crisis.

So all this time, lenders making jumbo loans haven’t been selling them. They’ve had all the risk, which translates into higher rates for jumbo borrowers.

But as we move further into 2011, jumbo securitizations are ramping up as private investors expect Fannie and Freddie to begin (an albeit long process of) winding down.

So now investment banks, money managers, and hedge funds are signing deals with mortgage lenders to purchase jumbo loans those lenders originate.

The most common deals being made right now are to make loans up to $2m with at least 20% equity required, and rates dropping as equity increases from 20% to 25% to 30%. Credit scores of 720, sometimes up to 740, are standard requirements. Jumbo borrowers typically must have 9-12 months’ total debt service left over after they close a loan, and some banks will count 60% of tax-deferred assets toward meeting this reserve goal. Others will only look at liquid assets as reserves.

Rates are in the low to mid 5s as of this writing.

Here are a few things you should look for in a jumbo lender:

(1) A lender that approves, funds, and closes their own loans, including jumbos. Ask these questions. Find out if you’re working with a broker who is taking your loan to a different bank, or if they’re the mortgage bank making the loan.

(2) A lender that guarantees assignment of a local appraiser to determine value for your purchase or refinance transactions. This is especially important on jumbo loans because the associated properties and neighborhoods usually have special characteristics that are unknown to out-of-area appraisers. A notable example is the higher amount of off-market sales that occur in jumbo markets. So an appraiser without intimate knowledge of your area might miss relevant comparable sales because they don’t know where to look.

(3) A loan agent who understands your jumbo borrower profile and can advise intelligently. They need to be able to brief you on tax issues with larger loans, because often to qualify for a larger loan, you’re subject to more stringent tax rules (e.g., Alternative Minimum Tax) that impact your mortgage interest deductibility. And they also need to understand how to analyze more complex income and asset profiles. If they stumble during initial consultations, the loan process will most likely stumble as well.

It’s important to note that the return of jumbo loans to select lenders is happening because those lenders have built a reputation for properly scrutinizing borrowers and properties—this scrutiny makes good loans, good loan pools make good securities, and more securities mean lower rates.

You should expect meticulous evaluation of your financial profile as your loan is approved, but that evaluation is not only used to approve your loan. It’s used to properly advise you on your broader financial objectives, provided your loan agent holds up your scrutiny during your initial consultation (see #3 above).