Jumbo Rip-Off
By Daniel Kadlec
Most people will never seek a "jumbo" mortgage--one too big to be sold to Fannie Mae or Freddie Mac, the federally chartered agencies that buy mortgages in the secondary market and virtually guarantee the availability of home loans for working stiffs. The breakpoint is high enough--$240,000 this year--that the higher interest rates on loans of that size afflict only one in five buyers nationwide. And so what? They can afford it, right? Don't be so sure. In today's torrid housing market, prices in some regions are escalating far faster than personal income, shoving more home buyers into jumboland without a paycheck to match. In Louisville, Dallas and Phoenix, prices are going up 7% to 10% a year. In Charleston, S.C., home prices rose 16% last year. In San Francisco the median home price rose 12%, to a pocket-draining $321,700. Let's put that number in perspective: to buy an average house with the standard 20% down, you would have to borrow $257,360--jum-booo!
Russ Marinello, a mortgage broker for Bay Counties Financial, says 80% of the mortgages he originates are jumbos--and no, it's not his specialty. The San Francisco area is unusually pricey. But jumbo creep is a broad issue. The breakpoint adjusts annually to match the rise in the national median home price, 5% last year. Still, in places where home prices are escalating faster than that, more buyers will be pushed into jumbos.
Today mortgage money is easy to find. A 30-year fixed-rate jumbo goes for about 7.08%--not that much more than the smaller "conforming" loan at 6.9%. Last October, though, jumbo borrowers had to pony up an average 7.22% when nonjumbo borrowers were paying only 6.76%, a punishing difference. On a $250,000 loan, that extra interest cost comes to $77.20 a month, or $27,792.13 over the life of the loan.
The travesty is that jumbo borrowers have a lower delinquency rate, and on that basis deserve a lower, not higher, mortgage rate. Other considerations muddy this analysis. But people who know about these things pretty much agree that credit risk plays virtually no role in setting the jumbo premium, which typically runs .25 to .5 percentage point above nonjumbo loans. That premium is the result of financing advantages enjoyed by Fannie and Freddie, who pass along lower costs to nonjumbo borrowers. The problem with this stealth socialism is that it does not take hot markets into account. The breakpoint should be scrapped. Critics would argue that it's a subsidy for the rich. But Fannie's and Freddie's advantages should work for everyone.
With rates near historic lows and jumbo rates relatively low compared to conventional mortgage rates, there's little reason to sweat this issue at the moment. Go for the jumbo if you can afford it. If you're just over the breakpoint, you could make a larger down payment to reduce your loan amount. But that money might be better spent in a stock fund. Another option is a piggyback structure, where you borrow just under the jumbo limit and take a second loan for the rest. That second mortgage comes at a hefty premium--maybe a couple of percentage points more than your first mortgage. But it may make sense if you retire the second loan quickly--say within five years. These options grow more valuable as rates rise and the jumbo premium widens--for as long as the dubious jumbo distinction is allowed to persist.
See time.com for more on mortgages. Dan's new book is Masters of the Universe. See him on CNNfn Tuesdays at 12:45 p.m. E.T.