Jim Pietrocini has joined the jumbo adjustable-rate mortgage party.
In early December, he refinanced his 4,600-square-foot Carlsbad, California, home that overlooks the Pacific Ocean. Pietrocini, a computer software consultant, couldn’t resist the deal on the jumbo, a loan exceeding the limit the government will buy. His $744,000 mortgage at 3.5 percent, which adjusts annually after seven years, will save him almost $8,000 a year compared with a fixed rate loan at 5 percent.
“I have two kids who are teenagers who probably will be gone in seven years,” said Pietrocini, 55. “My wife and I don’t need all this space for ourselves, so we’re probably going to downsize before the loan adjusts.”
Jumbo loans, both adjustable and fixed-rate, increased by 34 percent to $216 billion in the first nine months of this year, with ARMs comprising the majority of the gain, said Guy Cecala, publisher of Inside Mortgage Finance, a trade publication in Bethesda, Maryland. Cash-rich banks, including Wells Fargo Co. and Bank of America Corp., are using ARMs as a hedge: the loans’ longer-term payments will move in tandem with the lenders’ expected increases in borrowing costs as interest rates rise, said Greg McBride, a senior analyst at mortgage-data firm Bankrate Inc.
A decade ago, jumbo ARMs helped fuel the housing bubble by letting buyers qualify for homes they only could afford at the low rates before they reset. Banks approved mortgages based on the assumption that house prices would keep rising and the loans could be refinanced before higher costs kicked in.
When home prices stopped climbing in mid-2006, both jumbo and conventional ARM borrowers began defaulting in higher numbers, contributing to the collapse of the mortgage market that in turn led to the most severe financial crisis in decades.
“People have decided that whatever happened in 2008 is not going to happen again,” said Richard Lepre, a San Francisco-based loan officer with RPM Mortgage Inc. “There is not much concern about home values falling again. There is more concern about bank borrowing costs going up.”
Lenders pushed jumbo ARM rates down to a national average of 2.78 percent in the last week of November, the lowest in more than a year, according to Bankrate. In the same week, the jumbo fixed rate was 4.41 percent. On conventional mortgages, or loans below $417,000 for most of the country and $625,500 in high-cost regions, the average ARM rate was 3.54 percent and the average fixed rate was 4.33 percent in the same period.
Since 1999, jumbo ARM rates were typically about a quarter of a percentage point higher than conventional loans. That’s because banks can’t sell jumbo ARMs to Fannie Mae and Freddie Mac to have the government shoulder the risk as they do with conventional loans. During the credit crunch in 2008, the spread widened to more than a percentage point as bankers, who were concerned about defaults of jumbo ARMs on their books charged more for taking on the additional risk.
Today, ARMs often have rates that can triple when they reset — usually after a fixed period of five or seven years. The first rate adjustment may be as high as 5 percent or 6 percent, with subsequent annual changes capped at 2 percent.
Jumbo ARMs generally are lower risk than conventional ARMs because borrowers have greater resources to weather financial setbacks, said Jack Hartings, chief executive officer of Peoples Bank Co. in Coldwater, Ohio. Jumbo ARMs often require credit scores of 740 or higher, and owners must usually hold at least 20 percent to 25 percent equity in the property, he said.
“Jumbo borrowers usually have very high credit quality,” Hartings said. “They’ve built some net worth and assets and to be able to do that it takes good financial skills.”
In 2009, both ARM and fixed jumbos performed poorly. U.S. home loans of more than $1 million went bad at almost twice the rate of all mortgages, according to Irvine, California-based CoreLogic Inc. About 12 percent of the loans had payments overdue 90 days or more compared with 7.4 percent for all mortgages.
“Wealthy borrowers are not immune to foreclosure,” said Daren Blomquist, vice president of RealtyTrac, a real estate data firm in Irvine, California. “Each individual loan represents a much bigger risk to the lender because of its size, and losses are bigger — it’s harder to sell a $5 million home and the maintenance costs are higher.”
The higher default rate for high-balance loans stems partly from more affluent borrowers being more willing to walk away from mortgages they could afford after deeming the investment had gone bad, Blomquist said.
“High-end homeowners, even though they might have the means to withstand foreclosure, strategically default in greater numbers because they see it as financially smarter to cut their losses when a home is losing a large amount of value,” Blomquist said.
Greg Ptacek, who says he was burned by an ARM on his three-bedroom home in Los Angeles, is now trying to refinance with a fixed-rate loan of about $800,000. In 2006, at the top of the housing boom, he took out a 7.5 percent ARM that reset to 12.5 percent in 2012. By then, his red-stucco home had lost too much value to refinance.
“When we took out the mortgage, we didn’t know the housing collapse was about to start,” said Ptacek, a publicist with Arlene Howard Public Relations. “The mantra in the real estate boom was — don’t worry, home prices will keep going up and you can always refinance before the loan adjusts. I won’t fall for that again.”
The resurgence of jumbo loans is bolstered by a jump in home values that have made more buyers eligible because they’ve gained equity. In August, home prices spiked 13 percent compared with a year earlier, the biggest increase since the peak of the last real estate boom, according to the National Association of Realtors.
It’s also lifted by an economic recovery that has favored the upper echelon of earners. The share of income earned by the richest 10 percent of Americans last year was the biggest in about a century, according to Emmanuel Saez, an economist at the University of California at Berkeley. Those in the top one-tenth of income distribution earned almost 12 times what those in the bottom tenth made.
Some jumbo borrowers are so wealthy they don’t need a mortgage, said Lepre, the San Francisco loan officer. They’ll buy a home with cash and get a jumbo loan to put into investments.
“When the rate gets this low and you can put that money to work, jumbos are more than free,” Lepre said. “As long as you can make a greater return than the rate on the loan, you’re earning more than you’re paying.”
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