Mortgage Giants Aim to Reduce 'Jumbo' Rates

Fannie Mae (FNM Quote) and Freddie Mac (FRE Quote) think they can do what the Federal Reserve can't: lower the interest rates on residential mortgages.

While the Fed can cut only short-term interest rates, the two government-sponsored enterprises provide cheap, long-term financing for homeowners by purchasing their mortgages from banks. The loans are then repackaged and resold to investors.

But the mortgage giants are currently restricted from purchasing mortgages above the $417,000 limit on loans that conform to government guidelines. This pushes up rates on mortgages greater than $417,000, known as jumbo loans, because they are harder to sell to Wall Street firms.

The difference, or spread, between interest rates on jumbo and conforming mortgages widened sharply over the summer as uncertainty about the quality of loans made investors skittish about buying anything not guaranteed by Fannie or Freddie. As of last week, consumers were paying 92 basis points more on jumbo fixed-rate 30-year mortages than on conforming fixed-rate 30-year mortgages, according to data from HSH Associates.

By comparison, at the beginning of the year, consumers were paying less than 20 basis points more of interest on jumbo rates. (A basis point is a hundredth of a percentage point.)

The 50-basis-point cut in the federal funds rate Tuesday hasn't helped. As I wrote here earlier this week, mortgage rates tend to track yields on 10-year Treasuries. A survey of large lenders by Bankrate.com Wednesday shows the average interest rate on a 30-year, $165,000 mortgage actually rose slightly to 6.32% from 6.28% a week earlier.

Allowing Fannie and Freddie to purchase bigger loans would make cheaper financing available to more people, particularly in places such as California where prices remain high, even as the number of bad loans mounts.

In the past, some people in high-cost areas have taken out two separate, smaller loans to avoid paying jumbo rates, but lenders have become much less willing to issue second mortgages.

The spike in jumbo rates is creating pressure in Congress to loosen the reigns on Fannie and Freddie by allowing them to purchase bigger loans, at least temporarily. Fannie and Freddie went on the offensive at a House Financial Services Committee hearing Thursday. CEO Richard Syron said lifting the conforming-loan limit would spark more buying and selling of jumbo loans and thus bring down rates. He noted that the difference between conforming-loan and jumbo-loan rates is bigger than it has been in the past 20 years.