By the Numbers
A wide gap opens between conforming and jumbo mortgage rates
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The Fed’s changing appetite for agency MBS has likely helped shift the spread between conforming balance and jumbo mortgage rates. The average conforming borrower lately gets a rate 45 bp higher than the average jumbo borrower. The unusually wide spread should encourage banks to hold onto conforming loans and lower the securitization rate into agency MBS, forces that should narrow the spread eventually. It also creates prepayment differences between the sectors.
The difference between mortgage rates on conforming balance and jumbo loans has moved significantly this year. Both types of borrowers saw 30-year mortgage rates around 3.31% in early January, according to the Mortgage Bankers Association weekly survey of originators, but through April 8 the conforming average moved to 5.13% while the jumbo average moved only to 4.68% (Exhibit 1).
Exhibit 1: A wide gap between conforming balance and jumbo mortgage rates
Source: Mortgage Bankers Association
The most likely explanation for the sudden shift in rates is the change in Fed plans for holding MBS. The Fed signaled last year its intention to end QE by March. But this year it appears poised to let its portfolio run off and has floated the possibility of eventually selling MBS. A study of the spread between conforming and jumbo rates done at the American Enterprise Institute found that QE after 2008 helped pull conforming rates below jumbo and continued to influence the spread as the Fed let its portfolio plateau from 2014 through 2017 and then decline into early 2020. Other factors have played a part, too, including changes in Fannie Mae and Freddie Mac guarantee fees and differences in risk attributes between conforming and jumbo borrowers. The start of QE in March 2020 again pulled conforming rates below jumbo. And the anticipation of a Fed exit lately has likely pushed conforming rates above jumbo.
With the average note rate on conforming balances higher than on jumbo—controlling, of course, for differences in LTV, credit score and other risks—banks should see the conforming balances as better value and retain the loans in portfolio. The conforming loan has less negative convexity than the jumbo loan yet carries better due to the higher note rate. Banks may also shift some marginal lending toward conforming balances and away from jumbo. That should reduce the rates of securitization into agency pools, trim pool supply and help narrow the spread between conforming and jumbo loans.
In the meantime, the significant difference between conforming and jumbo rates changes relative prepayment risk across the sectors of the market. For the same note rate, a jumbo loan lately has had an extra 45 bp of incentive to refinance, which creates more negative convexity in the jumbo market. On the other hand, lower mortgage rates make it less expensive to sell one home and buy another, which could add a boost to prepayment speeds and reduce the negative convexity of discount jumbo MBS.
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