In the wake of the housing crisis, it became significantly harder to get a jumbo mortgage due to the risk factors involved. Jumbo mortgages have been making a comeback since then, but they now face a different style of threat – disincentives for high-end homeownership created by the recently enacted Tax Cuts and Jobs Act.
A jumbo mortgage refers to a loan that is beyond the "conforming loan" limits of the Federal Housing Finance Agency (FHFA). Loans beyond these limits are considered to be too risky to be guaranteed by Fannie Mae or Freddie Mac, the backing agencies under the supervision of the FHFA. They often come with other safeguards in the terms to limit risk to the lender.
Throughout most of the U.S. (approximately 93% of the 3,143 counties in the U.S.), the jumbo loan threshold value is $424,100. However, certain counties in areas with high housing costs have considerably higher limits for a jumbo loan. In high-dollar markets such as New York City and San Francisco, the threshold is $636,150 – and most of Hawaii has a threshold beyond that mark.
In better economic times, jumbo markets are cash cows for lending institutions. Larger loans provide more interest income for the lender. Since they are too large to be resold to Fannie Mae or Freddie Mac, they remain on the lender's books. By definition, these loans are targeted at wealthier buyers who represent a low risk of default in typical economic conditions.
According to Inside Mortgage Finance, jumbo mortgages in 2016 reached their highest dollar volume level since 2006, before the housing crisis put many high-end homeowners underwater and made jumbo loans too risky for most lenders.
Unfortunately, the new tax law is likely to reduce home purchases in the precise market for jumbo loans – high-end homes and high-dollar markets.
Two provisions of the law are particularly troublesome for jumbo loans. They lowered the limit for the mortgage interest deduction from $1 million to $750,000 for newly purchased homes, and they've also set the limit for total allowable federal deduction for state and local taxes at $10,000.
With the lower mortgage deduction limit, fewer homes in the jumbo loan range would benefit. The mortgage data firm Black Knight estimates that, depending on their tax bracket, homeowners with mortgage debt over $750,000 will absorb extra costs of $2,500 to $4,000 on average because of the new cap on interest deduction.
Current mortgages are grandfathered into the $1 million limit, giving existing high-end homeowners less incentive to move and possibly depressing the jumbo loan market by reducing the supply of high-end homes.
The property tax cap hits the jumbo market especially hard in high-tax states and cities. It's not difficult to reach $10,000 on property taxes alone in states such as New Jersey, Illinois, and New Hampshire, where property tax rates are all above 2.0%. Half of all states have tax rates at 1% or higher, meaning a home valued at $1 million would hit the state and local tax limit in those states based on property taxes alone.
The appeal of a second home is significantly diminished as a result. The $10,000 limit is collective, so it's likely that few, if any, of the property taxes on a second home would be deductible.
As a final disincentive, interest rates have been climbing slowly. While rates are still quite low in historical terms (just below 4% on a 30-year fixed rate loan as of this writing), the Federal Reserve is expected to raise interest rates between two and four more times during 2018. Every small increase in interest rates creates incentive for a homebuyer to re-think a jumbo loan.
Jumbo loans may be down, but they are definitely not out. Lenders will be competing for the remaining jumbo market, and may be able to come up with suitable interest rates or other incentives that tilt the balance more toward home ownership.
"Lenders have proprietary programs for 5% down or 10% down," notes Greg McBride, Chief Financial Analyst at Bankrate.com. "In particular, those 10% down and sometimes even 15% down loans will apply to larger, jumbo mortgages, which traditionally had an even higher down payment requirement at the outset."
If you are considering entering the housing market and taking on a jumbo loan, sharpen up your pencil. You have a lot of cost-benefit calculations ahead of you.
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