One type of home loan has become cheaper than others as rates spike. Here’s what it means for Bay Area real estate

The widening gap is a stark example of the squeeze that high housing prices and rising mortgage rates are putting on average home buyers, especially those entering the market.

“The conforming-loan buyers are usually first-time home buyers and they are really stretching to get into the market,” said Jim Wahlberg, a Compass agent in Danville. The rate hike “is often pricing them out of the market, because of the monthly cost.”

At the end of last year, the average rates on 30-year fixed-rate conforming and jumbo loans were about even — 3.33% and 3.31%, respectively. By the week ending May 6, the averages had jumped to 5.53% for conforming but only 5.08% for jumbos, according to the Mortgage Bankers Association.

On a $600,000 conforming loan, the difference between 3.33% and 5.53% adds $780 to a monthly mortgage payment. On a $1 million jumbo, the difference between 3.31% and 5.08% adds $1,032.

 One type of home loan has become cheaper than others as rates spike. Heres what it means for Bay Area real estate

The recent surge in mortgage rates is making it even harder for home buyers, especially for those needing conforming loans, which have shot up faster than rates on larger “jumbo” loans.

Yalonda M. James/The Chronicle 2021

Conforming loans must meet the federal underwriting guidelines of Fannie Mae and Freddie Mac. The standard dollar limit for a one-unit home this year is $647,200 in most parts of the country, but it can be up to 50% higher in high-cost areas. It’s at the max — $970,800 — in all Bay Area counties except Sonoma (where it’s $764,750), Napa ($897,000) and Solano ($647,200).

Jumbo loans are those that exceed Fannie/Freddie limits. Each lender sets its own rules for jumbos, but they typically require borrowers to have larger down payments and stronger financial profiles than needed for conforming loans. About 17% of all purchase and refinance mortgage rate locks in April were for non-conforming loans, mostly jumbos, according to Black Knight.

Colin Booth and his wife started looking for a home in Contra Costa County in September, when they were quoted rates under 3%. With two young boys, they started out targeting four-bedroom homes under $975,000 in Martinez and Pleasant Hill. After getting outbid multiple times, they offered as much as $1.2 million on one home. As home prices and interest rates marched upward, they revised their search to three-bedroom homes, then to neighboring Solano County.

They lucked into a four-bedroom home in Benicia where the owner was willing to sell for $875,000 after a previous deal fell through. They borrowed $743,750, which is higher than the maximum conforming-loan amount in Solano County, but they were able to lock in a jumbo rate of 4.625% in mid-April. Their mortgage broker “was saying jumbo was more advantageous even though it typically doesn’t work that way,” Booth said. They closed on Friday.

The spurt in mortgage rates is causing some buyers to look for cheaper houses or neighborhoods, switch from fixed- to adjustable-rate mortgages or move to the sidelines, according to local real estate and mortgage professionals. “Two clients this past week put the brakes on,” said Dawn Thomas, a Compass agent in Los Gatos.

A subset of conforming loans, that fall between the standard and high-cost limit for a county, are called high-balance conforming loans. They’re fairly common in the Bay Area, where the median price was $1.2 million for a single-family home and $775,000 for a condo in March.

High-balance conforming loans are still guaranteed by Fannie or Freddie and must meet their rules. Normally, their rates are higher than standard conforming loans (up to $647,200) but lower than jumbos. Today they’re higher than both, in some cases by nearly 1 percentage point.

One reason they’re higher: Earlier this year, Fannie and Freddie began imposing new fees on second-home mortgages and most high-balance conforming loans. The fees vary, but for most borrowers with loan-to-value ratios of 80% and above, they “would be roughly equivalent” to adding 0.25% to the loan rate, said Keith Gumbinger, a vice president with mortgage tracker

On Thursday, four Bay Area mortgage brokers quoted rates ranging from 5.125% to 5.375% for a standard conforming loan, 5.5% to 5.875% for a high-balance conforming loan and 4.75% to 5% for a jumbo loan. (These were their best rates for loans with 20% down and no points, a type of loan-origination fee. Rates change frequently and vary depending on home type, use and location, points, down payment and borrower profile.)

Some Bay Area borrowers needing a loan in the high six figures could save a little money by getting a jumbo instead of a high-balance conforming loan, but only if they can meet the stiffer jumbo requirements.

These rules vary, but the best jumbo loans generally demand at least 20% down, six to 12 months’ worth of monthly payments in reserves (cash or investments), a credit score of at least 680 to 700 and a total-debt-to-income ratio no higher than 43% or 45%.

By comparison, Fannie and Freddie will back loans with as little as 3% or 5% down for a primary residence, a 620 minimum credit score and a debt-to-income ratio up to almost 50%. They generally don’t require reserves.

After getting outbid on eight homes, Conery and Traci Wilbanks finally were able to buy a home in Oakland’s Maxwell Park neighborhood for $905,000 in April. They put down 20% and borrowed $724,000. Instead of getting a high-balance conforming loan, their mortgage broker — Zach Griffin of Guaranteed Rate Affinity in Berkeley — qualified them for a jumbo loan. They locked in a rate of 4% in March; at that time a high-balance conforming rate would have been about 4.75%, Griffin said.

Jay Voorhees, owner of in Walnut Creek, said only about half of his Bay Area clients borrowing between $647,200 to $970,800 could qualify for a jumbo mortgage. “About half can’t, because they don’t have the cash for the reserves or the down payment or their debt ratio is too high.” His purchase-loan volume is 15% to 20% below last year.

“There are a lot of first-time buyers freaked out,” said Brett Nicoletti, a branch manager with Academy Mortgage in Los Gatos. “I have a lot of Fannie Mae buyers who won’t fit into a jumbo slot. If they were looking at homes for $800,000, now they’re looking at $700,000. Wherever they were pushing their limits, now they are lowering their expectations.”

So why are jumbos cheaper than conforming mortgages? Their rates march to two different drummers.

Many banks plan to hold jumbos in their portfolios, and use their own cash to fund them. “This cash comes mostly from (customer) deposits, where rates are still very low, although reportedly creeping up a little,” Gumbinger said.

Conforming loans are usually packaged into mortgage-backed securities and sold to investors. Their pricing is based on what’s happening in the bond market, especially the 10-year Treasury yield, which has spiked from 1.5% on Dec. 31 to around 3% in early May. “This has kicked conforming mortgage rates higher very quickly,” Gumbinger said.

The Federal Reserve has also played a role, said Andy Walden, a vice president with Black Knight Data Analytics.

“During the early stages of the pandemic, banks were hesitant to lend due to uncertainty in the mortgage market and broader economy. This resulted in a pullback in jumbo lending” and higher rates for jumbo loans, Walden said via email. Meanwhile, the Fed brought down long-term interest rates by purchasing Treasury bonds and securities backed by conforming loans. “This drove down conforming loan interest rates and made them much more attractive” than jumbos.

“In recent months, the opposite has occurred,” he added. To fight soaring inflation, the Fed announced on May 4 that it will begin reducing its holdings of Treasury and mortgage-backed securities in June. “This has resulted in a sharp rise in 30-year conforming interest rates, as the largest buyer of conforming mortgage-backed securities exits the market. At the same time, banks have returned to jumbo lending. The combination of these factors” has made jumbo rates more attractive than conforming ones.

“Until the Fed’s plan is implemented and investors and markets see how that exit will unfold, I think we will see this extra upward pressure on conforming rates,” said Joel Kan, an economist with the Mortgage Bankers Association.

The mortgage rate increase “is certainly affecting affordability,” said Westin Miller, branch manager with Pinnacle Home Mortgage in Novato. But “I’m getting less pushback than I had expected. Maybe one-fourth of my pipeline of shoppers have dropped out. The other three-fourths are still in it. The group who are least deterred are older buyers; they all say look, I bought my first house when rates were 13%, so 5% is not a big deal.”

Bay Area real estate agents say the combination of exorbitant prices and rising interest rates has already weakened demand for housing.

“There is a little bit of softening in the market. A lot of buyers’ purchasing power has dropped dramatically. While we were seeing 10 offers six or seven weeks ago, every home I listed in the last month only got two offers each,” said Jason Moon, a Keller Williams agent in Walnut Creek.

“A lot of our buyers at the million-dollar range are paying all cash,” said Nina Havatny, a Compass agent in San Francisco. The interest rate bump “is not impacting them. But we are certainly seeing it in the $2.5 million to $4 million range. It’s really quite dramatic. We have one buyer who was trying to find a house in the Inner Sunset. She has given up, and is now going to renovate her (current) house.”

Patrick Carlisle, Compass’ chief market analyst, looked at year-over-year changes in the number of price reductions for the multicounty San Francisco metro area, through April 23. While the recent data is preliminary, “it looks like a consistent trend is beginning to develop, indicating that year over year, the number of price reductions is increasing — admittedly from a very low base last year — and the market has begun cooling from the extremely heated conditions which have existed,” he said via email.

Realtor D.J. Grubb, owner of the Grubb Co. in Oakland, doesn’t think interest rates will really impact home prices until they hit 7%. A bigger issue is “access to capital.” If the stock market keeps falling, many people will be unwilling to sell stocks to buy homes.

Where interest rates go is anyone’s guess. But it’s hard to see the Fed backing off its inflation-fighting efforts until prices, including home prices, cool off or there’s a stock market crash. That said, the Bay Area housing shortage has been so acute that it’s hard to see home prices tumbling unless the Fed goes too far and triggers a severe recession. If that happens, interest rates will come down, homes could become more affordable and people who took out a mortgage today could refinance at a lower rate.

Kathleen Pender is a freelance writer and former columnist for The San Francisco Chronicle. Twitter: @KathPender

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