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Will the "Jumbo Loan Penalty" Crush the Whole Housing Market?

I have seen - in the same neighborhood - 2,300 square foot houses with no no view, no garden, selling for $590K while 3,100 square foot houses (a few yards away) with mountain views, great gardens, selling for $620K. Are we going to see a domino effect where the $590K home has no buyer (since everybody wants the under-priced $620K house rather than over-priced $590k), driving the price to below $430K for the 2,300 square foot house, as a side effect of the "Jumbo Loan Penalty"?

This would result in houses with a selling price of $380K to go down to $300K, forcing houses at $300K to go down to $220K, and houses at $220K to go down to $150K.

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Permalink Reply by Rushabh Sheth on August 11, 2009 at 5:55pm: Hello Vincent,

In the example you posit, it is more than likely that the price of the property is being driven by the underlying land, rather than the condition of the house itself. I agree that there should be a little bit bigger price differential between those two properties but it can't be too much, again because of the land value.

I think the price of a house is driven by three primary factors in the specific order: location and zoning regulations (which drives the land value), supply/demand dynamics, and house condition.

In my opinion, any domino effect will be localized to areas that have liberal zoning regulations and are not close to the city center. Distant suburbs will be the first to fall. As you get closer to the city, fewer and fewer dominoes will fall. Again, zoning regulations and land availability play a major role in this.

Also, what is this "Jumbo Loan Penalty"? Are you referring to the interest rate differential between conforming and jumbo loans? I am not sure why you believe this differential will lead to a collapse in housing price to the extent that you described.; ▶ Reply to This

Permalink Reply by Vincent Granville on August 11, 2009 at 7:10pm: The "Jumbo Loan Penalty" is the fact that mortgages above $417K are more difficult to obtain and usually result in an higher interest rate.

The example, comparing a 2300 square foot home selling for $590K with a 3100 square foot home selling for $620K in the same block, is based on a buyer with $180K in cash (down payment), who can easily obtain a loan and buy the small $590K home, but who will be turned down for the $620K loan due to his $597K threshold ($417K + $180K).

At some point, the owner of the $620K home (e.g. a laid-off Microsoft employee) will sell it for $589K, thus driving down the price of the $590K house.

Just my 2 cents, hopefully I'm wrong. I agree that in the short term, the city centers will better withstand the storm, but in the long term, I believe that the suburbs will do better, especially if you have land to grow vegetables, a good climate, and can be sustainable. I have heard about VC firms possibly investing in tall skyscrapers used exclusively to grow vegetables (they could be built in city centers and serve city inhabitants), but I'm not sure if this is going to happen.; ▶ Reply to This

Permalink Reply by Rushabh Sheth on August 12, 2009 at 3:43pm: Hello Vincent,

Thanks for the details about the example. The seller of the $620K house has the option of carrying financing for the difference between $598K and $620K. If the seller was willing to sell for $598K AND the buyer is willing to purchase at $620K (eg. the buyer believes the house is worth at least $620K), then it is a no-brainer for the seller to sell at $620K and carry the financing for the $22K difference.

The Jumbo Loan Penalty assumes that the seller is unable or unwilling to finance some of the purchase price to bridge the gap between the conforming loan amount and the actual amount required to complete the purchase.

It is the seller financing that will prevent the pushing over of dominos. But of course, everything depends on the demand side of the equation. If the asking price is acceptable to the demand side then the market will find a way to complete the sale at that price. Seller financing is just one creative financing option available to the marketplace when the more traditional options are lacking or unavailable.; ▶ Reply to This

Permalink Reply by Vincent Granville on August 12, 2009 at 6:57pm: Hi Rushabh,

I agree with you, if the seller is smart and wealthy enough to offer a $22k loan. Some will, some won't. Some, like myself, will choose to not sell.

Vincent; ▶ Reply to This