If you’re in the mortgage business you automatically know what these terms mean. And they’re important but if you’re not in the business you might have a vague awareness of the terms, especially if you’ve recently bought a financed a home here in the San Jose area. In other parts of the country where home values aren’t as high, most consumers probably don’t recognize the terms because the majority of home loans issued today across the country are conforming loans. In fact, about two out of every three outstanding mortgages today are of the conforming variety. But let’s take a closer look at each category and they they’re important.
First, let’s review what lenders refer to as the secondary market. The secondary market is the world of mortgages after a loan has already been approved and funded. Once a mortgage company approves a loan, funds, and closes it, the mortgage company sells it in the secondary market. Most every mortgage loan issued today is sold. Why are loans bought and sold? For one thing, if a mortgage company didn’t have the ability to sell a loan, pretty soon it would run out of cash. The secondary market might seem kind of surprising to some but if they step back for a moment and think of the impact of making a $500,000 mortgage on a lender’s bank account, then it starts to make sense. Instead, a mortgage company funds loans with a line of credit. The line of credit is tapped in order to fund the mortgage and then sells it, replenishing the credit line.
Lenders can make money in the mortgage business by selling the loan or keeping it and collecting interest on the loan. But that can take a long time to recover the cost of originating, processing and funding a loan by collecting interest each month. Instead of collecting interest, they sell it. Who do they sell it to? Most often it’s Fannie Mae or Freddie Mac.
It’s these two industry giants that set the parameters for the secondary market for most all loans. If a lender approves a loan following these predetermined guidelines, the loan can then be sold, freeing up cash. That’s the original charter for both Fannie and Freddie, to create and foster liquidity in the mortgage market. Lenders can sell directly to Fannie or Freddie on a loan-by-loan basis or they can sell a package of them. When multiple loans are bundled together, it’s considered a “bulk” sale.
The guidelines for conforming loans are the basis for other loan programs. For instance, to verify a borrower’s income, the loan will ask for the most recent pay check stub covering a 30-day period while also showing a year-to-date total. If the loan being sold only has one pay check stub covering a 15-day period, it doesn’t meet the guideline and is not eligible for sale. Again, the majority of loans issued today are either Fannie or Freddie.
The most competitive rates for either can be found in the conforming range. For most parts of the country, this loan limit is currently $453,100 but can change each year based upon a preexisting model. The Federal Housing Finance Agency pulls up the national median home value in October and compares it with the previous years’ value. If there’s an increase from year to year, the conforming loan limit will be increased by the same percentage. If there is a decrease, the loan limit actually stays the same. It’s for this reason that the conforming loan limit was stuck at $417,000 for so long. Home values began to fall precipitously beginning around 2008-2009 and fell so much that it took years to get back up to the pre-2008 levels. Because the model doesn’t lower the conforming limit when values go down, the conforming loan limit stayed the same. In fact, it stayed the same for so long, that the conforming limit was left unchanged for nearly 10 years.
A high balance conforming loan is also eligible for sale in the secondary market. A high balance loan also follows the guidelines previously laid out by Fannie and Freddie. There are few differences between a conforming limit and a high balance conforming limit except the interest rate on the two will be slightly higher with a high balance mortgage. The minimum down payment for a high balance loan is 5.0%. A high balance loan is the primary option in so-called “high cost” areas, such as San Jose and surrounding areas. The Federal Housing Finance Agency has set guidelines that define a high cost loan. In San Jose, the high balance conforming loan limit is $679,650.
The third category is jumbo. Again, here in San Jose, a jumbo loan is anything above the high balance conforming loan limit. Jumbo loan rates will be higher than conforming or high balance as there is no secondary market for jumbos. Instead, a mortgage company will act on behalf of a jumbo lender, originate, process and fund the loan based upon the jumbo lender’s terms. Once the loan is closed, the loan is sold directly to the lender issuing the guidelines.
In San Jose, with the median home values near $1,000,000, most loans will either be high balance conforming or a jumbo.
One final word about guidelines and it applies to all three categories. Overlays. Lenders must approve loans using the predetermined guidelines but may also put additional requirements on the loan. For example, a loan program might require a credit score of 700 but a lender overlay might ask for a 720 score for the very same loan program. Lenders can add overlays to a particular loan program but cannot ignore other guidelines. As long as the overlay applies to all borrowers under the same circumstances, lenders can add additional requirements. This is why someone who gets turned down at a bank might get an approval at a mortgage company under the very same conditions.