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October 1, 2011 was a dark day in the nation's most expensive housing markets. That's the day higher loan limits expired and the sky was expected to fall.

When Loan Limits Fell, Jumbos Started Jumping

October 1, 2011 was a dark day for the nation’s most expensive housing markets. That’s the day higher loan limits expired and the sky was expected to fall.

Terrible things were supposed to happen with loan limits raises on a temporary basis three years earlier expired thirteen months ago. “Housing markets remain fragile and cannot handle a mortgage disruption like lower loan limits. With tight underwriting already constraining mortgage availability, lowering the loan limits will only further restrict liquidity,” warned a coalition of the nation’s most powerful housing lobby groups in a desperate but unsuccessful eleventh hour effort to keep the higher limits in place.

Limits on the size of mortgages that conform to the mortgage underwriting guidelines of Fannie Mae or Freddie Mac are set by law. Mortgages meeting these criteria are securitized on Wall Street as mortgage-backed bonds, making them slightly less expensive to borrowers. Loan limits had been temporarily increased in 2008 in direct response to the collapse of the housing market and the credit crisis. After the increase expired on October 1, the maximum loan that Fannie Mae and Freddie Mac could back fell from $625,500 to $417,000.

In the intervening months, financing for larger loans has been readily available. In fact, there has been a resurgence of loans greater than the loan limits, or “jumbo” loans. Some typically go up to $2 million and even more – far beyond what Fannie Mae and Freddie Mac will buy.

Few are securitized; private market securitization has yet to return to health. From 2008 to 2010 there were no securitizations on newly issued mortgages without government backing. Since 2010 there have only been eight securitizations of newly issued mortgages, jumbo or non-agency loans, without government backing for a total of $3.7 billion. Five of these eight non-agency securitizations have been in 2012. By comparison, non-agency securitizations peaked at $1.2 trillion in each of 2005 and 2006. Lenders doing jumbo loans have mostly been retaining them on their balance sheets because there has been no place to sell them.

In part because they are not securitized by Fannie or Freddie, jumbo mortgages carry higher interest rates, so they’re more profitable for lenders. Yet the difference in rates is not overwhelming. Current average rates (November 20) for a conforming thirty-year fixed mortgages are 3.373 percent. Average rates for a 30-year fixed jumbo are 3.938 percent.

However, the higher rates make all the difference to lenders. With a lot fewer product offerings today then during the boom, lenders are finding jumbos to be a great source of profits. Moreover, the upper end of the housing market is healing like the rest of real estate, though perhaps not as quickly. The recovery has been led by lower priced homes, where inventories are tightest. However, luxury home prices across the country are stable, according to the Institute for Luxury Home Market, and many market report increased activity.

Lenders financed $38 billion in private jumbo mortgages during the second quarter of 2012, up 65 percent from a year earlier, according to new data compiled by Inside Mortgage Finance. That is the highest quarterly dollar amount since the first quarter of 2008. Jumbo loans accounted for about 15 percent of the total dollar amount of mortgages distributed by Bank of America Corp, during the second quarter of 2012, up from 4 percent a year earlier. At Wells Fargo & Co., private jumbo volume more than doubled in the first half of the year from the same period last year. Citigroup Inc. also says it has increased jumbo lending.

In a Southern California region that includes Orange County; jumbo loans were 20.4 percent of all purchase loans in August. That’s the highest percentage since December 2007, when they were at 21.7 percent, said Andrew LePage, an analyst at DataQuick. The number of jumbo mortgages approved in Massachusetts by lenders nearly doubled last year from 2010 and is on pace this year to exceed 2011′s total of almost 14,000 loans, worth a total of nearly $10 billion, according to Warren Group, a Boston firm that tracks real estate.

But the downside can be steep. As recently as a year ago, Moody’s called jumbo loan holders facing persistent negative equity a “greater strategic default risk” than other homeowners – meaning they were more likely to bail on their mortgages than even subprime borrowers.

The sea changes in lending standards required of new borrowers that were imposed between 2008 and 2010 have a created more safer lending conditions for lenders Mortgage brokers say lenders are more willing to take risks now, but they still put borrowers under a microscope. If a loan goes south, there obviously are fewer people on the market for a multimillion-dollar property than a two-bedroom condo purchased with a conforming loan. So the reserves required to get a jumbo can run six months to a year or more, compared with just a couple of months on a conforming loan. Jumbo down payments of 20 percent to 40 percent are common, though some loans can be had with a 10 percent down payment and hefty mortgage insurance.

“What’s encouraging is the lenders are getting brave again,” Jeff Lazerson, president of Mortgage Grader in Laguna Niguel told the Orange County Register. “But they’re getting brave because the market is healing and there’s a lot less risk than there was.”

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