Jumbos Still Cheaper Than Conforming Mortgages

For years mortgage rates on “jumbo” loans (definition) have been higher than for traditional (conforming) mortgages (definition). Since jumbo loans were larger than the upper limit permitted to be packaged and sold to Fannie and Freddie, banks would typically charge a premium for “illiquidity” on these products. But starting last year conforming mortgages became more expensive for borrowers than jumbo loans. 

Source: Barchart

This distortion persists today and is directly related to the Fed’s quantitative easing program. Since conforming loans are funded via agency MBS (bonds that Fannie and Freddie sell to fund purchasers of pools of conforming loans from banks), the pricing on these loans is directly linked to MBS yields. And as discussed last year (see post) the Fed has been dominating the MBS market via QE3. As the Fed’s taper expectations took hold (after Bernanke’s May 22nd speech), MBS yields rose sharply. With that, conforming mortgage rates also increased.

Jumbo mortgage rates on the other hand rose more slowly because these loans tend to stay on banks’ balance sheets and are not funded with MBS. Moreover banks are happy to get paid a lower rate on loans to these higher net-worth creditworthy clients. Banks fund themselves with near-free deposits and charge jumbo clients 4.25%, keeping the spread. And unlike conforming loans that get sold at “market” levels, banks don’t have to mark jumbo loans to market (banking book accounting treatment is based on accruals unless there is an impairment). The dynamics of conforming mortgages being more directly tied to MBS pricing (which is impacted by the Fed’s securities purchases) and different accounting treatment have resulted in 30-year jumbos being some 20 basis points cheaper than standard mortgages.