Larger Loan Amounts: Tighter Rules for Lending

Most of the time, I'm talking and writing about the sort of loan the average borrower is looking for. Up to 125% of the single unit conforming loan limit of $417,000, which works out to $521,250, A paper guidelines are pretty much determined by Freddie and Fannie. There really aren't many breakpoints in policy. Some lenders charge extra for loans under $100,000 or so, but it's really all the same program. Even in pricey Southern California, this is most transactions. Even if you don't have a down payment, anything above 80% Loan to Value Ratio is going to get split into a conforming first and a second for the remainder, so you're still dealing with Fannie and Freddie. If Fannie Mae or Freddie Mac will buy the loan, the lender is happy with it. An acceptance from either of their automated underwriting programs is normally good as gold for getting the loan through. My lowest "no points" conforming rate is currently 6.875, which for a $522,000 property with no second loan, just property taxes and insurance, and no other debt, you'd have to be making $7550 per month to qualify for that loan, or $90,600 per year. Most people, even without debts, don't make that much. Add in an average amount of household debt, a higher rate second mortgage, and increase the loan amount, and you're looking at roughly $10,000 per month to qualify, even without the fact that the maximum allowable debt to income ratio decreases.



However, once you get above dollar amounts that Fannie Mae and Freddie Mac will buy, each lender has their own criteria for the so-called "Jumbo" loans. This used to be a lot more of a factor in 2003 and 2004 when the conforming limits were $322,700 and $333,700, respectively, and still a significant factor in 2005 when the conforming limit was $359,650 and the market was still hot. When the average purchase price is in excess of $500,000 and even 80% of it is well over the conforming loan limit, you've got yourself a jumbo. Furthermore, scenarios that would be perfectly acceptable A paper below the conforming limit - because Fannie and Freddie will buy them, thereby assuming the risk - can often be forced to go sub-prime once you get into jumbo territory. For instance, from one lender whom I've done 100% A paper with below the conforming limit, they won't touch 100% financing once it gets above $417,000. If your first loan amount is for $418,000 and you want 100% financing, your choices are 1) do it sub-prime 2) Find a down payment of at least 5% somewhere, or 3) find some other A Paper lender that will do 100% jumbos. Right now, with the lenders in a panic, that's tough.



Regular jumbos go up to about $650,000 or $750,000. These numbers haven't changed much in at least five years, and we're getting to the point where jumbo limits need to rise. It's one thing when it covers a huge band from $322,700 to $650,000. It's getting to be something else when the band has constricted at the bottom so that it doesn't start until $417,000. Let the conforming loan maximum get boosted again, and regular jumbo loans may become more rare than they are.



Above jumbo loan amounts is "super jumbo" territory. Now instead of being willing to go to 95% financing, albeit full documentation only, 90% is as high as this particular lender will go. Matter of fact, in order to find a 100% program in super jumbo territory, I have to go to Alt-A programs, which is no longer A paper.



What's going on here? Quite simply, higher dollar value properties are harder to sell, and there's more risk of taking at least something of a loss on them. Furthermore, the lender is risking a higher number of their own dollars. They want the borrower to have some serious skin in the game to motivate them not to lose it. You can find lenders willing to go 100%, even now with the lenders in full panic mode. It will be expensive, no matter how good your credit, no matter how much you make. We can make things better by splitting the loans, but even so, expect the subordinate loans to have rates well into the double digits. Furthermore, you can bet on there being a pre-payment penalty on at least one of the loans, while if you bring a satisfactory down payment to the table, you can find rates that are much better, and without a pre-payment penalty. For example, using the same rate sheet, the add to the jumbo rates is 3/8ths of a point for super jumbo, which means you can have the same rates as a jumbo loan for an additional charge, or go up maybe an eighth of a percent on the rate for the same charge. 3/8ths of a point doesn't sound like much, but when you're talking $800,000 loans, it's a $3000 one time fee, or about $1000 extra per year in interest. However, since in order to qualify for an $800,000 loan at 7%, you've got to be making about $14,000 per month not including the effects of property taxes, homeowner's insurance, or other debts - probably around $18,000 minimum salary per month to qualify with those included - these are not loans for even your average white collar worker.



At $1,000,000 in loan amount, there's another break point in lender policy. For instance, the lender I've been covering closest won't touch anything above 80% financing. Period, end of sentence. Not as a first, not with a piggyback second, not at all. For A paper lenders, that's actually kind of generous. The next two A paper sheets I pulled out max out at 70% Loan to Value above a million. This means come in with 20 to 30% down payment - or go sub-prime, with higher rates and pre-payment penalties. When you're talking about million dollar loan amounts, pre-payment penalties can fund a fairly high end car. For instance, if you have (pinky finger extended, Dr. Evil style) one million dollars at 8%, a standard pre-payment penalty of six months interest is $40,000. Once again, these are not loans for your average person. Even if you have no other debts, by the time you get done with property taxes and homeowner's insurance, you're looking at $24,000 monthly income to qualify. Still, it's nearly two months income for a pre-payment penalty!



Just in case my readers include a significant number of the richest hundredth of a percent of the world population, there are usually break-points at 1.5 million, 2 million, and 3 million as well, and that's if the lender goes that high. The biggest residential loan I've ever done doesn't get into these categories. In practice, the rule seems to be the bigger the house, the bigger the down payment they have, not only in absolute terms but also in terms of percentage. If I got a request for a loan that big, I'd just go ask the wholesale executives if they can do it, and what it's going to take. I have a suspicion that most loans of this size end up being commercial loans in all but name, or perhaps even in name.



Nor is it just the guidelines that get tougher. Underwriting gets trickier the higher up on the scale you go. Loans with characteristics that would be a slam dunk if they were conforming become nightmares above the million dollar line. What's going on, of course, is that the underwriter is more reluctant to sign their name to a loan commitment that exposes the lender to five times as much loss. People get fired when those go sour, and they don't give out a whole lot of second chances for high dollar loan amounts going south. So when they write that commitment, that underwriter is going to make very certain all of their bases are covered.



Pretty much every loan program in existence has a maximum dollar value, above which the lender offering it has decreed that it does not exist. Sub-prime breakpoints are different from A paper - half a million and two million are the most common breakpoints there - but I've never found a loan program from any lender that didn't have a maximum dollar value they'd lend under that program. Even hard money lenders have maximum dollar amounts they'll lend, price and policy and underwriting breakpoints. The average person really has no need to be aware of these breakpoints, but if you do start hitting them, you'll figure it out in a hurry. Things that are easy on conforming loan amounts sometimes cannot be done at all once you're no longer in conforming loan territory.



Caveat Emptor