Why ‘Jumbo’ Rates Exceed ‘Conforming’ Loans

We’ve gotten several letters since we started this column a month ago. Here are some of the more interesting questions from the mailbag:

Ken Brown of Los Angeles, who says he has been shopping for a home loan, asks an easy question that has a complex answer: “What’s the difference between a ‘conforming’ loan and a ‘jumbo’ loan, and why are rates on jumbo loans higher?”

A conforming loan is a loan that doesn’t exceed $187,600, a congressionally set ceiling. Lenders who make a loan for that amount or less often sell the loan to the Federal National Mortgage Assn. (Fannie Mae) or the Federal Home Loan Mortgage Corp. (Freddie Mac). Those two agencies pool the loans they buy and then sell shares in the pools to investors.

The money that investors pay for these shares gives Fannie Mae and Freddie Mac more cash to buy more mortgages, which in turn gives lenders more money to make home loans.

A jumbo loan--often called a “nonconforming” loan--is for more than $187,600. Lenders who make jumbo loans can’t sell them to Fannie Mae or Freddie Mac.

Instead, these lenders often must keep the loans in their portfolio until the mortgages are paid off. That’s one reason why interest rates on jumbo loans are higher than rates on conforming loans.

Since the lender may be holding the loan for up to 30 years, it protects itself against future interest-rate increases by charging a rate that’s about one percentage point higher than the rate it charges on conforming loans.

The $187,600 ceiling will be raised in the next few weeks. Although the new limit hasn’t been set yet, it will likely top $200,000. That’s good news for home buyers, because they’ll be able to borrow more money at lower rates than they can today.

The Oct. 29 column urging readers to see if they can drop their private mortgage insurance triggered several letters from homeowners who had financed their homes with the help of the Federal Housing Administration. These readers wondered if they, too, can have their mortgage insurance dropped if they have at least a 20% equity stake in their property.

The answer, sadly, is no. The insurance premium that FHA borrowers pay--an amount equal to 3.8% of the total loan amount--can virtually never be dropped because most lenders who make the loans eventually sell them to the Government National Mortgage Assn. Much like Fannie Mae and Freddie Mac, the GNMA--nicknamed Ginnie Mae--then pools the government-backed FHA loans and sells shares in the pools to investors.

Since the mortgages are backed by the federal government, so are the Ginnie Mae securities--a factor that attracts safety-conscious investors.

If homeowners were allowed to cancel their FHA insurance premiums, Ginnie Maes would no longer have government backing and many investors wouldn’t buy them. Rates on the securities would have to be raised or less money would flow into the nation’s housing market, either of which would have an adverse trickle-down effect on mortgage rates.

Since you can’t drop your FHA insurance premium, look at the bright side: It’s basically a “user-fee” for a loan that enabled you to purchase a house that you probably couldn’t have afforded otherwise.

Maria Sanchez of Riverside writes: “We sold our house almost three months ago to a single woman. Her offer was contingent on getting a loan for $97,000, but the bank she was working with turned her down. Our mortgage broker says she could get a loan through him, but now she doesn’t want our house. Can we keep the $2,000 deposit she made on our house?”

Sorry, you’re probably out of luck. If the buyer made a reasonable attempt to get a mortgage but couldn’t qualify for the loan, the contingency will likely let her off the hook and you’ll have to refund her deposit.

If the mortgage broker can give her a loan on the same terms that she was seeking from the other lender, you may be able to successfully sue for breach of contract and maybe even for monetary damages. But litigation involves lots of time, money and aggravation, and there’s no guarantee that you’ll win.

You’re probably better off just giving her back her deposit and putting the home on the market again.

“I have an adjustable-rate mortgage that is based on the 11th District Cost of Funds Index,” writes R. Martin of Thousand Oaks. “How can I find out where the index is now?”

The 11th District Cost of Funds is a composite index figure that reflects the rate the Federal Home Loan Bank charges lenders for a variety of different loans. It’s the most widely used index for ARMs in California and several other states.

You can get the latest index figure by calling the FHLB’s toll-free number, (800) 824-6560, or by calling direct (415) 393-1418. The Times publishes the latest figure in the Business section on Mondays.

The index has gradually been dropping over the past few months and now stands at 8.807%. Remember, though, that’s not the rate that you’ll be charged on your loan: Among other considerations, you must also factor in the lender’s “margin,” or markup, on your mortgage.