By the Numbers

Differences in mortgage rates help FHA, jumbo loans

Brian Landy, CFA | March 25, 2022

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

Mortgage rates have increased more than 125 bp this year, leaving only 6% of borrowers in conventional agency MBS pools 75 bp or more in-the-money to refinance and promising slower prepayment speeds. But rates have not increased as much for jumbo and FHA borrowers, according to mortgage rate lock data compiled by Black Knight’s Optimal Blue. Speeds for FHA and jumbo loans may fall less than conventional agency MBS borrowers since FHA and jumbo borrowers have less lock-in to their current loans. That should help lift purchase and cash-out prepayment speeds in FHA and jumbo loans, a benefit for MBS trading below par.

Conventional mortgage rates have reached 4.71% while jumbo rates are only 4.28%, according to Optimal Blue’s mortgage rate lock data (Exhibit 1). The two rates were similar at the start of 2020, but the pandemic disrupted the market for private label securitizations (PLS) and sent jumbo rates higher. The jumbo rate stayed higher than the conventional rate until late 2020, when the two rates converged as the PLS market recovered. The two rates were similar for most of 2021. However, over the last few months jumbo rates have not increased as much as conventional rates and are currently 43 bp lower than conventional.

Exhibit 1. Conventional rates increased more than jumbo rates this year

The conventional mortgage rate includes all agency-conforming loan balances, including jumbo conforming. The jumbo rate includes only loans with balances larger than agency limits.
Source: Optimal Blue, Amherst Pierpont Securities

Even borrowers that are out-of-the-money to refinance have some sensitivity to mortgage rates. Borrowers are more reluctant to move or do a cash-out refinance if the new loan will have a higher interest rate. Some borrowers will be unable to avoid a move. Others will decide that a cash-out refinance to assist with debt consolidation is still more sensible than paying high credit card interest rates. But borrowers that can defer a new home purchase or don’t need the cash will not prepay. This effect is known as lock-in.

The jumbo-to-conventional spread has fallen below the VA-to-conventional spread (Exhibit 2). Originators typically offer VA loans at lower rates than other products since the loan is guaranteed by the Department of Veterans Affairs. This allows Ginnie Mae to charge a much lower guaranty fee than Fannie Mae and Freddie Mac. FHA borrowers typically have worse credit than VA borrowers; even though the loan is insured by the FHA, the servicer can face higher costs dealing with delinquent loans. Over the last year FHA loans were typically up to 10 bp higher than conventional, but recently have fallen below conventional rates.

Exhibit 2. FHA, VA, and jumbo spreads to conventional

Spreads vs. conventional mortgage rate. The conventional mortgage rate includes all agency-conforming loan balances, including jumbo conforming. The jumbo rate includes only loans with balances larger than agency limits.
Source: Optimal Blue, Amherst Pierpont Securities

Borrowers with weak credit typically get higher rates. The rate premium helps the borrower pay upfront credit fees charged by Fannie Mae and Freddie Mac and any additional fees charged by lenders. But credit spreads have generally tightened since mid-2021 (Exhibit 3). Spreads for borrowers with credit scores below 720 have been volatile this year, but recently have fallen to a 2-year low. Spreads are 5 bp to 10 bp lower than at the start of 2020. Low FICO loans typically prepay faster than high FICO loans when they are out-of-the-money and having rate spreads compress should help.

Exhibit 3. Rate premiums for lower credit borrowers have fallen

Source: Optimal Blue, Amherst Pierpont Securities

The rate lock data is a good predictor of the average rate received by conventional borrowers (Exhibit 4). This chart compares the spread between loans issued in new Fannie Mae and Freddie Mac pools to the average rate conventional rate lock series. The rate lock data is shifted to account for the lag between lock and closing. With only a few exceptions the spread was less than ±5 bp since the start of 2017.

Exhibit 4. Spread between conventional rate locks and conventional origination

Source: Optimal Blue, Amherst Pierpont Securities

The jumbo rate lock data has also been a good predictor of the note rate of loans in prime jumbo 2.0 securities (Exhibit 5). The spread has typically been less than 10 bp, so also appears to be a good indicator of the current jumbo mortgage rate.

Exhibit 5. Spread between jumbo rate locks and originations in prime jumbo 2.0 securities

Source: Optimal Blue, Amherst Pierpont Securities

Brian Landy, CFA
brian.landy@santander.us
1 (646) 776-7795

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