The jumbo mortgage market in the United States was virtually non-existent from 2008 until late 2010, but this was not due to a complete lack of demand or drastic property price reduction. The luxury real estate market actually fared better than average homes during the Great Recession, but many of those purchase transactions were settled with the buyers bringing cash to the closing table. Jumbo mortgages these days are all the rage, and this is largely due to improvements in the secondary mortgage market.
A major reason for the disappearance of jumbo loans until their resurgence in early 2011 was the lack of securitization. After the collapse of the mortgage credit markets in 2008, investors were only interested in purchasing mortgage-backed securities (MBS) guaranteed by Fannie Mae or Freddie Mac, which do not guarantee jumbo mortgages. Some banks offered jumbo MBS instruments to investors, but the poor performance of jumbo borrowers during the Great Recession did not help the secondary market.
Celebrities such as actor Nicholas Cage, singer Toni Braxton and former Major League Baseball player Jose Canseco are infamous for defaulting or strategically walking away from their million-dollar jumbo commitments, and mortgage lenders know that many high-income borrowers tend to be profligate spenders whose personal financial records show lackluster histories. That has changed, however, thanks to years of strict mortgage lending guidelines that have reduced the number of late payments and loan defaults. Investors are once again seeing jumbo MBS securities as attractive investments.
Jumbo MBS Instruments Become Attractive
Low mortgage interest rates have also made jumbo home loans attractive to borrowers and investors alike. Ever since the Federal Reserve Bank became the number one MBS investor in the U.S., the difference between conventional mortgage annual percentage rates has been almost negligible. This makes them competitive with their Fannie and Freddie conventional mortgage counterparts.
Current jumbo mortgage applications require a greater degree of due diligence, which greatly reduces their risk; they are also cheaper to originate and to bundle into securities. During the Great Recession, the few lenders that offered jumbo home loans did so at their own risk, effectively carrying the mortgages on their balance sheets. In this case, the lender passes on the risk to the borrower in the form of higher fees. Securitization makes jumbo mortgage lending cheaper and more enticing for applicants.
There is yet another reason for MBS investors to look at jumbo instruments: Fannie and Freddie have significantly increased the cost of their guarantee issuance. What this means for mortgage lenders is that conventional home loan origination will come with greater costs and narrower margins, and thus jumbo mortgages may become more profitable once they are bundled into MBS packages.