The Lending Landscape in 2014: Jumbo Loans

JumboAs the name implies, a “jumbo” loan is big one; it exceeds $417,000 in most parts of the country except Alaska and Hawaii. In Alaska and other federally designated high priced markets, it is $625,000.  In Hawaii it is $721,050.  These limits – known as “conforming loan limits” – are set by Fannie and Freddie, the large government-owned purchasers of conventional loans in the secondary mortgage market.  Historically, jumbos, being non-conforming loans, carried higher interest rates and stricter underwriting standards.  However, interest rates on jumbos have been going down, and in some instances, have reached near parity with conforming loans. [See my article here.]

When interest rates ticked up in the Spring of 2013, something happened.  Banks began to see their loan originations and refinancings slow considerably.  This is a source of concern to the country’s big lenders.[1]

It is expected that in 2014, for some folks, jumbos may be easier to obtain.  According to a recent Wall Street Journal article “The Era of Big Loans” the landscape may be changing, as lenders focus on wealthier borrowers and try, at the same time, to maneuver through the thicket of stricter regulatory requirements imposed by the Consumer Finance Protection Bureau (“CFPB”).

But before discussing the points made in the WSJ article, it is important to understand two new terms that will become a part of the lender’s lexicon in 2014.

The CFPB has created a category of loan called a “QM,” or Qualified Mortgage.” QMs must be fully amortizing, not more than 30 years, free of the teaser interest rates, negative amortizations, and the other gimmicks of the easy money days, circa 2005 – 2008, when the primary underwriting requirement for a loan was a pulse rate.

Additionally, the borrower of a QM may not have a “back-end”[2]  debt-to-income (“DTI”) ratio over 43%.  Coupled with the QM rules, are the Ability to Repay (“ATR”) rules, which require that lenders make a good faith underwriting effort.  QMs are legally conclusively presumed to comply with the ATR rules; non-QMs have only a rebuttable presumption of compliance. The difference is significant, since for non-QM loans, the ATR rules permit the borrower to claim that the lender did not adequately vet their borrowing capacity, and made them a loan they could not afford – thereby entitling the borrower to seek a return of the interest paid on the loan.

Here are the salient points of the article which suggests that Big Banks, such as Wells Fargo, in an effort to boost their loan originations, are going after the non-QM market in jumbo loans.

  • Lower Down Payments.

Lenders started lowering down-payment requirements last year. Most notably, Wells Fargo began accepting 15% down payments for jumbos, down from 20%, and Bank of America made the same change for loans of up to $1 million. Experts say more lenders will likely follow and that some will begin accepting 10% down payments.

  • No Mortgage Insurance.

So far, most jumbo lenders aren’t requiring private mortgage insurance—an added expense that was widely employed during the housing boom to lessen losses from borrowers who went into foreclosure. But that is expected to change this year. Private insurers say lenders have been contacting them about reintroducing this cost.

  • Higher DTI Ratios. For example, Zions Bank of Salt Lake City permits a DTI ratio:

…as high as 50%. But those borrowers need to meet stricter guidelines, including a higher FICO credit score and provide documentation proving they have six to 18 months of mortgage payments (including taxes and insurance) in cash reserves….

  • Relaxed Loan Documentation.

Affluent jumbo borrowers have been able to provide partial documentation with some lenders and still get approved—a setup that helped those who are self-employed or have complex income structures.

  • Bigger Push to ARMs.

Banks will likely ramp up their pitches for adjustable-rate jumbos—in indirect ways. Tom Wind, executive vice president of home lending at EverBank, says lenders will slowly raise rates on 30-year fixed-rates jumbos, which will result in more borrowers turning to ARMs. Banks hold most private jumbos on their books and prefer ARMs because once their rates reset, they stand to receive larger interest payments from borrowers. While the CFPB’s new mortgage rules have made qualifying for these loans tougher—lenders can no longer approve borrowers based on the loan’s introductory rate—that is unlikely to affect wealthy home buyers who have the income or assets to qualify at a higher rate.

  • Rate Changes.

Mortgage experts say jumbo rates are likely to remain low this year in comparison with non-jumbos. Lenders are still courting affluent borrowers and want to add more of these loans to their books. The lowest rates will continue to be on the adjustable-rate jumbos while fixed-rate jumbos are expected to get pricier later in the year.

Conclusion.  The good news is that at least for one segment of the economy – the affluent – mortgage lending may not dry up in 2014.

But what about the Little Guy who was decimated from the last five years?  I may eat my words, but I believe the rapid drop-off in loan origination and refinancing business that lenders experienced in 2013, may push more of them into loan products that are not QMs. [According to the article cited at footnote 1, the Mortgage Bankers Association’s 2014 forecast for loan originations and refinancings of $1.2 trillion, represents “…the lowest level in 14 years.”] This will be especially true if interest rates tick up – resulting in fewer refinancings and leaving more lenders competing on the loan origination side of their business.  This isn’t to say that in the rush to originate banks will not thoroughly vet their average borrowers following ATR rules – just that the loan products they offer may not be fully QM compliant – especially when it comes to offering adjustable rate products, which were a staple for borrowers in the years leading up to the credit and housing crisis of 2008-2009.

Secondly, and this opinion takes me farther out on the veritable limb, if we see the return of a more chastened and wiser “Private Label”[3] secondary mortgage market, lenders may have a source for selling their “QM-lite” products.  Time will tell.

[1] See Wall Street Journal article, “Banks Cut as Mortgage Boom Ends”, January 9, 2014.

[2] That is, the ratio of total monthly household debt (mortgages payments and all other living expenses) to total gross monthly income from all sources. Conversely, a “front end ratio” is the ratio of total mortgage debt (principal, interest, taxes, insurance, including mortgage insurance, if any) to total gross monthly income from all sources.

[3] That is, a private secondary market that is willing to purchase the non-conforming loans shunned by Fannie and Freddie.