Real Estate Update in Palo Alto & Los Altos

People getting plain-vanilla mortgages benefited this week from a few weeks’ worth of turmoil in the markets for jumbo and stated-income home loans.

There was a plunge in the average rates on conforming mortgages — home loans of $417,000 or less for which the borrowers documented their incomes. And that drop was an indirect reaction to the troubles afflicting jumbo loans (mortgages for more than $417,000).

The benchmark 30-year fixed-rate mortgage fell 10 basis points to 6.58 percent, according to the Bankrate.com national survey of large lenders. A basis point is one-hundredth of 1 percentage point. The mortgages in this week’s survey had an average total of 0.28 discount and origination points. One year ago, the mortgage index was 6.48 percent; four weeks ago, it was 6.75 percent.

The benchmark 15-year fixed-rate mortgage fell 11 basis points to 6.24 percent. The benchmark 5/1 adjustable-rate mortgage jumped 11 basis points to 6.64 percent.

Weekly national mortgage survey
Results of Bankrate.com’s Aug. 22, 2007, weekly national survey of large lenders and the effect on monthly payments for a $165,000 loan:
30-year fixed 15-year fixed 5-year ARM
This week’s rate:              6.58%               6.24%             6.64%
Change from last week:   -0.10                -0.11              +0.11
Monthly payment:          $1,051.61         $1,413.85       $1,058.15
Change from last week:  -$10.91             -$9.91            +$11.98

From January through July, jumbo mortgages appeared to be insulated from the problems in the subprime mortgage market. That changed around the beginning of August. Abruptly, lenders restricted borrowers’ access to jumbo loans, and rates went up. Lenders took those actions because investors suddenly stopped buying closed jumbo loans from lenders.

When investors buy mortgages, they rely on statistical models that predict, among other things, how many of the loans in a given pool of mortgages will eventually go into default. They use the information to figure out how much each loan pool is worth and how much the related securities and derivatives are worth.

Toward the end of July, investors suddenly became worried that their models were wrong for jumbo mortgages. Not only did they realize the predictions were inaccurate, but they didn’t know how inaccurate. Investors didn’t know how to value the loan pools and related securities. So they stopped buying jumbo loans.

Alt-A problems
Similar issues cropped up for Alt-A mortgages, which is a catchall term for home loans that have nontraditional aspects. Stated-income loans, in which the borrower doesn’t submit documents to prove income, are the dominant species of Alt-A. Many stated-income borrowers lied about their incomes so they could qualify for mortgages; investors don’t know how many of these borrowers lied, or by how much they exaggerated their incomes.

It boiled down to this: Investors didn’t want to buy jumbo and Alt-A loans from lenders. But they still wanted to buy mortgages, says Dan Dowling, president of United Mortgage Capital Corp. in Altamonte Springs, Fla. And what types of mortgages were remaining on the virtual shelves? Those boring old conforming loans, with a long track record that makes them easier to value when they’re pooled and securitized.

Prius vs. Hummer
It helps to think of conforming mortgages as Toyota Priuses and jumbo loans as Hummers. When consumers fear gasoline shortages, those plain old Priuses suddenly seem sexy, and Hummers are bummers. Prices of Priuses jump up. Similarly, enthusiastic investors bidded up prices on bonds backed by conforming mortgages. And when bond prices rise, yields fall — and rates follow yields downward.

“Of all the available mortgage-backed securities, we just wiped out Alt-A and subprime,” Dowling says. “There’s more money competing for fewer products, causing rates to fall.”

The Federal Reserve helped, too. In an effort to keep the debt markets functioning, the Fed lowered the discount rate last week and hinted that it might cut the federal funds rate next month or at the end of October. That drove down Treasury yields, and caused investors to seek the relatively higher yields on mortgage-backed securities. Same story: The increased demand for mortgage-backed securities sent prices higher and drove yields lower — and rates fell, too.

From bankrate.com