Interest rates for jumbo loans not likely to drop

WASHINGTON — The piece of the government's economic-stimulus plan aimed at bolstering the housing market may not work out as planned.

While Fannie Mae and Freddie Mac can now purchase and guarantee home loans of up to $729,750, they won't be traded in a key secondary market, limiting the prospect for sharply lower rates on "jumbo" mortgages.

To address the worst housing crisis in decades, the $168 billion economic-stimulus package President Bush signed this month included a temporary increase in the cap on mortgages that the government-sponsored companies can purchase or guarantee, from $417,000 to $729,750 in high-cost markets. The change will be in effect through 2008.

In theory, this was supposed to spark investor demand for securities made up of higher-value mortgages backed by Fannie and Freddie, which would have the effect of driving down interest rates on jumbo loans and spur home buying and refinancing activity. In practice, the impact is expected to be muted.

That's because mortgages above the conforming loan limit of $417,000 will not be allowed to be blended into packages of other loans traded in what is known as the "to-be-announced" (TBA) secondary market.

Greater risks

The rationale is that these larger loans carry greater risks and would thereby push up prices for securities tied to conforming loans, according to Wall Street's biggest trade group, the Securities Industry and Financial Markets Association.

The association said that segregating the new securities would be the "least disruptive option."

Because the securities derived from Fannie- and Freddie-backed jumbo loans will be traded in less liquid markets, the interest rates on these loans will need to be higher to attract investors.

And that's less-than-ideal for consumers looking to take out or refinance jumbo home loans.

"It's sort of an artificial barrier to segregate the loans in this way," said Lawrence Yun, chief economist at the National Association of Realtors.

Rather than separating loans based on whether they fall above or below the $417,000 level, Yun said it might make sense to assess each mortgage on the basis of their relative risk profile, or by which geographic area they are in.

Interest rates on jumbo mortgages have been running about a percentage point higher than those for conforming loans. That unusually wide spread is a reflection of investors' post-credit crunch wariness toward mortgages not backed by Fannie, Freddie or Ginnie Mae, a government agency that sells bonds backed by the Federal Housing Administration.

The rates for jumbo loans "will come down, but not as much as they could be," Yun said. He did not want to predict a specific level but noted that even a narrowing of the spread to half a percentage point "can certainly provide a significant boost" to the market. Before the credit crunch, a quarter-point spread was common.

Financing the bigger mortgages is considered riskier because they are prevalent in high-cost areas, meaning a boom-to-bust scenario carries greater financial weight. Plus, bigger mortgages require banks to hold more capital in reserve in case of a default.

Paying off loans

Another consideration on Wall Street is that homeowners who take out bigger loans tend to pay them off faster, reducing interest payments made over the life of the mortgage.

Fannie and Freddie guarantee payments of principal and interest over the life of the loan — and charge banks and other lenders fees for that guarantee.

For a variety of reasons, Fannie and Freddie likely won't begin to buy the costlier mortgages and bundle them into securities for sale on Wall Street until sometime in the April-June quarter.

"There are a lot of lenders and consumers that are eagerly awaiting" to refinance their jumbo mortgages, said Doug Duvall, a spokesman for McLean, Va.-based Freddie Mac. Spokesmen for Fannie Mae had no comment.

James Lockhart, director of the Office of Federal Housing Enterprise Oversight, which supervises Fannie and Freddie, said it remains to be seen just how much the spread narrows between conforming loans and the new class of jumbo loans. But "we don't disagree" with the decision to separate the new jumbo securities from the TBA market, he said.