A Fading Middle-Class Perk: Lower Mortgage Rates
For three decades, the U.S. middle class enjoyed a rare financial advantage over the wealthy: lower mortgage rates.
Now, even that perk is fading away.
Most ordinary homebuyers are paying the same or higher rates than the fortunate few who can afford much more.
Rates for a conventional 30-year fixed mortgage are averaging 4.48 percent, according to Bankrate. For “jumbo” mortgages — those above $417,000 in much of the country — the average is 4.47 percent.
This trend reflects the widening wealth gap between the richest Americans and everyone else. Bankers now view jumbo borrowers as safer and shrewder bets even though conventional borrowers put less capital at risk.
Even as the overall U.S. housing recovery has slowed, sales of homes above $1 million have surged in the past year. Price gains have been so great in some areas that middle-class buyers are straining to afford even modest homes. They’re also facing tighter lending rules, larger down-payment requirements and a shortage of houses for sale.
Used to be, rates for conventional mortgages would be 0.2 to 0.3 of a point below rates on jumbo mortgages. A decade ago, a conventional rate averaged 5.68 percent, a jumbo 5.97 percent. The advantage for middle-class borrowers was possible in part because government-chartered firms guarantee that lenders will be paid on a conventional mortgage even if a borrower defaults. No such guarantee exists for jumbos.
Two factors have caused the spread between conventional and jumbo rates to vanish:
— The government in 2012 began raising the fees it charges lenders for guaranteeing payments on conventional mortgages. Lenders passed along that increase to borrowers in the form of higher rates. The fees are meant to stop home buyers from once again borrowing more than they can afford — a trend that fueled the 2007 housing bust.
— Bankers say they’ve begun using mortgage rates to woo high-net-worth clients: Attractive rates on jumbos have become a way to secure additional business from those clients — from managing their investments to supplying a broad suite of financial services. What’s more, those borrowers tend to be clustered in neighborhoods that lenders consider more stable.
“Jumbo borrowers represent the holy grail of what financial institutions are pursuing: that much-desired, mass affluent consumer,” said Greg McBride, a senior analyst at Bankrate.
In the first three months of 2014, 37 percent of the money Bank of America lent for mortgages went to jumbos, compared with 22 percent at the same point last year.
The lower rates are geared for affluent borrowers living in “sweet spots” with strong employment and stable home prices — areas like metro New York City, Boston and sections of California, said Matt Vernon, who leads consumer mortgage lending at Bank of America.
“We’re lending where we believe home ownership is sustainable,” Vernon said.
Wells Fargo offers jumbos starting at 4.25 percent, about 0.25 point lower than for conventional mortgages. This month, Wells trumpeted the spillover benefits of increased jumbo lending: A 14 percent year-over-year increase in loans from its separate “wealth, brokerage and retirement” division.
“Hopefully, it’ll continue to go up,” Wells’ CFO, Timothy Sloan, said of prospects for continued jumbo lending.
Sales of homes exceeding $1 million leapt 7.8 percent over the past 12 months. That contrasted with a 7.5 percent drop in overall home-buying in that period, according to the National Association of Realtors.
Prices have appreciated in areas such as San Francisco, New York and Washington, which have higher thresholds for jumbo mortgages than the national average. Jumbos in these cities are for loans above $625,500, about $200,000 more than the national average.
The median price of a two-bedroom home in San Francisco is $1.02 million, according to the real estate site Trulia. The median for New York City homes: $1.2 million.
Nationwide, just 2 percent of homes fetch prices that large.
Jumbos are a necessity for nearly everyone in communities such as La Jolla, Calif. That’s where Aniqa Jaswal and her husband in February bought a four-bedroom house about 10 minutes from the beach.
“There are no homes below jumbo mortgage prices here,” Jaswal said.
The trend coincides with the lopsided nature of the U.S. economy’s nearly 5-year-old recovery. Almost all the U.S. incomes gains from 2009 to 2012 flowed to the top 1 percent of earners, according to tax data analyzed by economist Emmanuel Saez at the University of California, Berkeley.
By contrast, median household income was $51,017 in 2012, $4,600 below its peak in 2007, according to the Census Bureau. Squeezed by scant pay raises, the middle class has struggled or hesitated to take on mortgage debt. Many recall the high-risk loans that ignited the housing meltdown and led to the financial crisis and recession.
Not even jumbo borrowers feel completely safe. Some are borrowing in anticipation of setbacks in an economy where bills can multiply even when incomes barely budge.
One is Stephanie Kellen, who in December refinanced her home in Marin County, Calif., with a jumbo. The lower-than-usual jumbo rate helped replace a line of credit for her husband’s auto repair business.
“The best way to have security was to have low interest rate loans for as long as possible,” Kellen said.
Nearly one in five homeowners still owe more on their mortgage than their homes are worth. Without home equity, they have little or no wealth even as richer Americans have benefited from rising prices for stocks and upper-end real estate.
At the same time, the government has reduced its support for middle class homeownership after having rescued two companies, Fannie Mae and Freddie Mac, that enabled lower rates. The housing bust devastated Fannie and Freddie, which guarantee conventional mortgage payments. Both were forced into federal control at taxpayer cost.
To limit taxpayer exposure, Fannie’s and Freddie’s regulator required them to raise fees for guaranteeing mortgages. Those fee increases have boosted conventional mortgage rates and likely blunted the effectiveness of the Federal Reserve’s efforts to keep rates low to invigorate the housing market and the economy.
“We’re cutting off the avenue that has the most proven success in wealth building,” said David Min, a professor at the University of California, Irvine, who specializes in mortgage finance.
The higher fees have left the industry concerned that more people won’t be able to afford to buy, said Bob Walters, chief economist at Quicken Loans, though the fees might help protect some people from assuming unaffordable debt.
Walters doubts that rates for traditional mortgages will ever again fall meaningfully below jumbo rates.
“I don’t see the days of those microscopic guarantee fees coming back,” he said.