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> Before the pandemic, lenders were falling over each other to welcome jumbo borrowers, who generated fat profits even though they were the least likely to defa

> Before the pandemic, lenders were falling over each other to welcome jumbo borrowers, who generated fat profits even though they were the least likely to default. Even though? Implying loans that default are normally the most profitable? Am I misreading this?

eli_gottlieb 7y ago
Normally, doesn't the interest rate track the likelihood of default?
ascagnel_ 7y ago
From reading the article, this may be because the banks choose to service the loans directly, or because the loans have priced-in higher risk (as they lack a government guarantee).
magicsmoke 7y ago
Loans that are likely to default have higher interest rates. However, jumbo loans also have high interest rates due to the size of the principal. Although they're supposed to be less likely to default, being held by high-income individuals, if they do default then you lose more principal than a regular loan. For a bank in good times, you get to charge high interest rates normally reserved for risky borrowers on safe borrowers. More profit with less risk, what's not to like? In bad times though, when those previously safe borrowers start defaulting, even if only a few of them default they do so on larger chunks of money. Instead of losing your money with many small cuts now you could end up losing money in chunks.
- t0mas88 7y ago
  But in a well working market, why wouldn't bank X provide a lower rate than bank Y if the loan is less risk and very profitable? And then bank Z sees a potential profit and undercuts bank X. Repeat until you get a rate that reflects the risk? So the real question is: What is wrong in the high-end US mortgage market? Are banks breaking anti-trust laws and setting price floors?
  - magicsmoke 7y ago
    Because they aren't really low risk. There's two different kinds of risk being referenced here. Risk 1: High chance of default. This is the risk you take by lending to borrowers with poor credit. Risk 2: Low chance of default, but when defaults happen you take a big hit. These are jumbo loans. Banks recognize that Risk 2 has inherent costs that require a higher interest rate. My previous wording of "More profit with less risk" was false. More profit with less Risk 1, but that's because you're taking on Risk 2.
- naveen99 7y ago
  I think the reason they aren’t doing loans is because there has been a >20% decrease in real estate value given the slow down in travel and even commuting to work. it’s clear from reit prices. it’s just that the residential market is very high friction and illiquid that we don’t see the price change on Zillow yet.
wonderwonder 7y ago
Its somewhat poorly worded. They are implying that they are a rare combo of low risk, high reward.

eli_gottlieb 7y ago

Normally, doesn't the interest rate track the likelihood of default?

ascagnel_ 7y ago

From reading the article, this may be because the banks choose to service the loans directly, or because the loans have priced-in higher risk (as they lack a government guarantee).

magicsmoke 7y ago

Loans that are likely to default have higher interest rates. However, jumbo loans also have high interest rates due to the size of the principal. Although they're supposed to be less likely to default, being held by high-income individuals, if they do default then you lose more principal than a regular loan. For a bank in good times, you get to charge high interest rates normally reserved for risky borrowers on safe borrowers. More profit with less risk, what's not to like? In bad times though, when those previously safe borrowers start defaulting, even if only a few of them default they do so on larger chunks of money. Instead of losing your money with many small cuts now you could end up losing money in chunks.

t0mas88 7y ago
But in a well working market, why wouldn't bank X provide a lower rate than bank Y if the loan is less risk and very profitable? And then bank Z sees a potential profit and undercuts bank X. Repeat until you get a rate that reflects the risk? So the real question is: What is wrong in the high-end US mortgage market? Are banks breaking anti-trust laws and setting price floors?
- magicsmoke 7y ago
  Because they aren't really low risk. There's two different kinds of risk being referenced here. Risk 1: High chance of default. This is the risk you take by lending to borrowers with poor credit. Risk 2: Low chance of default, but when defaults happen you take a big hit. These are jumbo loans. Banks recognize that Risk 2 has inherent costs that require a higher interest rate. My previous wording of "More profit with less risk" was false. More profit with less Risk 1, but that's because you're taking on Risk 2.
naveen99 7y ago
I think the reason they aren’t doing loans is because there has been a >20% decrease in real estate value given the slow down in travel and even commuting to work. it’s clear from reit prices. it’s just that the residential market is very high friction and illiquid that we don’t see the price change on Zillow yet.

wonderwonder 7y ago

Its somewhat poorly worded. They are implying that they are a rare combo of low risk, high reward.