2017 Jumbo Loans: Full Doc and Made to Prime Credits

Large-balance mortgage loans are not only for wealthy homebuyers but also for middle-income borrowers in high-cost areas. Also known as ‘jumbo’ loans, historically these loans had a higher interest rate than conforming loans. However, since mid-2013 a jumbo loan has been cheaper to borrow than a conforming mortgage loan, by an average of 21 basis points during the first quarter of 2017.[1]

Mortgage rates fluctuate following other interest rates in the capital markets, and vary by loan product, term, and size.  Figure 1 displays the average interest rate in Q1 2017 compared to 2009 by loan origination amount, expressed as the difference between the loan amount and the local-market conforming loan limit. The blue line in the figure shows that the interest rates in Q1 2017 declined gradually with the loan amount until the conforming loan limit is reached. Then the rates dropped abruptly by 20 basis points before it started to decline gradually again. The chart shows an inverse relationship between the interest rate and the loan origination amount. The general trend reflects various fixed-costs of an origination; in other words, the fixed-cost per loan size declines as the loan size increases. Similar to Q1 2017, the interest rates in 2009 declined gradually with the loan amount until the conforming loan limit was reached. However, then the rates took a sharp 82 basis point rise. The historical trend of mortgage rates spiking above the conforming loan limit has reversed making the jumbo loan cheaper than in the past.

Figure 2 shows the trend of spread between the average interest rate for conforming loans and jumbo loans. Jumbo loans are cheaper if the blue line is above zero and conforming loans are cheaper if this line is below zero. As seen in the figure, conforming loans were a better deal during the period of Q2 2007 to Q1 2013. The spread reached its bottom in Q2 2009, making conforming loans cheaper by more than 80 basis points. However, the spread reversed in Q2 2013 and continued to stay the same till today (jumbo loans cheaper than conforming loans). The red line in the figure shows that the share of jumbo loans plummeted as the spread plunged negatively and started to increase slowly as the spread narrowed and eventually turned positive. The share of jumbo loans has reached its highest since 2009 at about 16 percent of home-purchase originations (in dollars); in 2009 the jumbo share was just 6 percent.

The credit risk characteristics of jumbo loans have evolved overtime. Today nearly all jumbo loans are full doc and made to prime borrowers, lowering credit risk across two dimensions. However, jumbo loans today generally have higher investor and condo/co-op shares, which can add to credit risk.

To illustrate, the average credit score for homebuyers with 30-year fixed-rate jumbo loans increased 40 points between 2001 and Q1 2017, rising from 731 to 771. However, the average loan-to-value ratio (LTV) for homebuyers with jumbo loans in Q1 2017 was similar to 2001, holding steady at 77 percent, and the average debt-to-income ratio (DTI) for homebuyers with jumbo loans in Q1 2017 rose slightly from 2001, from 31 percent to 33 percent.^[2]

Figure 3 plots the six indicators used to calculate the Housing Credit Index (HCI) for prime jumbo home-purchase loans. The blue hexagon represents an index of credit-risk attributes in the benchmark period (average of 2001-2003 set equal to 100 for each attribute) and the red polygon represents characteristics of loans made in Q1 2017 relative to the benchmark. The share of borrowers with a credit score of less than 640 dropped to zero percent compared to 3.4 percent in the 2001-2003 benchmark period. The low- and no-doc share was down significantly compared to the 2001-2003 benchmark period. The share of jumbo loans with an LTV of 95 percent or higher was slightly below the benchmark period, and the share of loans with a DTI at-or-above 40 percent was similar to the benchmark period. In contrast, the investor-owned share was 79 percent higher than the benchmark period, and the condo/co-op share doubled the benchmark level.

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