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Private capital is returning to the mortgage market

Shrinking spread between jumbo and conforming mortgages is a positive indicator

The spread between jumbo and conforming mortgages is shrinking. And that’s a good thing for the mortgage market. It means that private capital is coming back into the market, according to analysis from Capital Economics.

“We think that the decline in the jumbo-conforming mortgage interest rate spread is a positive sign for the future of the mortgage market,” Capital Economics Property Economist Paul Diggle said.

The spread between jumbo and conforming mortgages has progressively fallen since the early part of 2013, even turning negative for a brief period in February. Diggle says this is due to two factors:

  • The guarantee fees which Fannie Mae and Freddie Mac charge lenders for buying or guaranteeing mortgages, and which lenders pass on to borrowers in the form of higher rates, have increased. Put-back risk, as well as a 10-basis-point premium mandated by the Treasury, has been behind the rise in guarantee fees. But guarantee fees do not apply to jumbo mortgages, meaning that the increase in fees has served to close the jumbo-conforming spread.
  • The tapering of the Fed’s asset purchase program, which includes purchases of agency mortgage-backed securities, has driven an increase in conforming mortgage rates. The Fed has been buying only those mortgage bonds issued by the GSEs, which are by definition made up of conforming mortgages. So while the winding down of the program has led to an increase in conforming mortgage rates, it has hardly affected jumbo mortgage rates.

Diggle says that the shrinking spread is a positive for mortgage lending. “After all, the spread is one indicator of the willingness or ability of private capital to compete with GSE money in the mortgage market,” he said.

“Consistent with that, the evidence suggests that jumbo mortgages are becoming increasingly available. In addition, the tight spread is an encouraging step towards the goal of running down the role of Fannie Mae and Freddie Mac in the mortgage market. That’s arguably the single most important reform which would put the US housing market on a long-term sustainable path.”

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