Jumbo Home Loans – Why The Rates Are Higher Than Conforming Loans

By Mitch Reynolds · Leave a Comment

Many people claim that jumbo home loans rates are higher than conforming loan rates because they pose a higher risk to the mortgage company that originates the loan. While this is true, the main reason why jumbo home mortgage loans are more risky than traditional ones is not the reason I have seen cited most frequently (at least in my not so humble opinion).

The reason that most people site for interest rates on jumbo home loans to be more risky is that higher-costing homes are harder to resale in case of default due to less demand for homes. This puts the jumbo market more susceptible to price swings in market booms and busts.

The logic behind this at first glance seems reasonable, and there is some truth to it, but not complete truth. Assuming that higher cost homes are harder to sell because there is less demand than traditional homes also assumes that there is the same amount of supply as traditional homes. There is not, which leads me to think that there is another reason.

The real reason why jumbo home loans are more expensive than other loans is because they do not have the American tax payers subsidizing them. Traditional loans are packaged and sold to the quasi-government entities Freddie Mac and Fannie Mae (of course, at the time of this writing, they are fully fledged government entities since they were taken over during the housing crash of ’08). These securities are then backed by the implicit guarantee (right now explicit guarantee) of the United States Government. And the government gets it’s backing from the US taxpayer = the US taxpayer is backing those traditional mortgages.

Having the governments backing significantly reduces the risk for loan originators of conforming loans, making it very difficult for jumbo home loans to compete (impossible really). The mortgage lender can simply originate the loan, then sell it off to Fannie or Freddie, get the loan off its balance sheet, and pocket the profit from the origination.

Is this a good thing? Well, that’s another question, and one that I will not answer right now in detail. In short, I think it can be a good thing when done properly (which has not happened). So what does this mean for those people who are looking to secure jumbo home loans? It means that they will either have to find a way to make a bigger down payment to get the loan value below conforming limits, or they will have to pay a higher interest rate.