Housing Woes Hit High End Too

The subprime mortgage collapse isn't just threatening the market for low-end homes; it's also afflicting luxury homes, reports Fortune's Jon Birger.

By Jon Birger

September 21, 2007

What could the collapse in the subprime mortgage market possibly have to do with whether Dr. Jeffrey and Madeline Stier get full price for their four-bedroom house in the wealthy New York City suburb of Larchmont?

Not much, you would think. After all, the people who live in Larchmont tend to be lawyers, doctors, and Wall Streeters. Generally speaking, they aren't the credit-challenged borrowers who must resort to subprime mortgages to finance their homes.

And yet talk to the Stiers about the tepid demand for their home–a lovely Tudor on a tree-canopied cul-de-sac near the local elementary school–and it's clear that what's happening in the subprime market is reverberating all the way up the real estate food chain.

Not only has the collapse driven up rates on many kinds of mortgages, but fear of a stock crash–one perhaps sparked by the bursting of the credit bubble–has for now prompted many high-end homebuyers to either trim their offers or stop shopping altogether.

"It's the hysteria on Wall Street," Jeffrey Stier says. "It's frightening people."

The timing has been unfortunate for the Stiers. Their house, which they've owned for 30 years, boasts a stylish outdoor pool, a modern kitchen, and a nicely renovated master bathroom.

Given its location and amenities, it probably would have sparked a bidding war had it been put up for sale a year ago. But today, six months after the Stiers first listed it for sale at $2.5 million–a price only slightly above what comparable homes had been selling for–the house remains unsold. Tired of waiting, the Stiers finally capitulated and recently dropped their asking price to $1.99 million.

The market's psychology has changed more than the fundamentals, argues Phyllis Radding, a veteran Coldwell Banker agent who is selling the Stiers' home. "All the negative articles in the press have made buyers more cautious," she asserts.

Psychology does seem to be darkening the high-end market. But it's more than just fear. A recent spike in rates on so-called jumbo mortgages is raising the cost of buying an expensive home. The combined effect of psychology and higher rates is simple but brutal: A theoretical buyer is likely to offer you less–maybe 10% to 15% less–than he might have just one month ago.

The jumbos are probably a bigger impediment than fear. The term refers to home loans in excess of $417,000. By rule, they cannot be guaranteed by the government-sponsored mortgage finance companies Fannie Mae and Freddie Mac. Of late, if Fannie or Freddie aren't vouching for your loan, there's trouble.

As with most mortgages, jumbos are typically bundled together by lenders and then resold to investors (often mutual or pension funds) as mortgage-backed securities. The problem: The rising number of defaults on subprime mortgages–particularly among borrowers who took out interest-only or other exotic loans–has laid bare the, um, less than diligent practices of many lenders.

That has spooked investors and dried up the secondary market for mortgages–even those of sterling quality–that aren't guaranteed by Fannie or Freddie.

Unable to resell their jumbo mortgages on Wall Street, lenders are now making far fewer mega-loans, and those they are making charge much more onerous interest.

For years jumbo rates were only 0.25 of a percentage point above those of "conforming" loans–those below the cutoff (now $417,000). In recent weeks that spread has exploded to 0.75 of a percentage point or more. BankRate.com reports that the average tariff on jumbo loans soared to 7.35% nationally in August, and many mortgage brokers are reporting figures that exceed 8%.

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