An exchange rate is simply a score for one currency against another and represents the number of units of one currency that need to be exchanged for a single unit of another currency. The exchange rate is thus the price of one currency against another and, given the number of world currencies today, within the US alone there are literally dozens of exchange rates. Now that seems simple enough but, unfortunately, it is not quite that easy.

Quite apart from these simple exchange rates, which are sometimes referred to as ‘spot’ rates, there are also a whole range of ‘trade weighted’ or ‘effective’ rates which show the movement of one currency against an average of several other currencies. There are also exchange rates which are used in markets such as the forwards markets in which delivery dates are set at some point in the future, rather than at the time of the initial transaction. In other words, there is no such thing as an exchange rate, but are in fact a series of different exchange rates depending upon the nature of the transaction.

The foreign exchange market is driven largely by supply and demand and the exchange rate between any two currencies at any moment in time is influenced substantially by the interaction of the various players in the market. In a few cases currencies are still fixed, or the exchange rate is set by the monetary authorities, and when this is the case the country’s central bank will normally intervene if required and either buy or sell the currency to keep its exchange rate within a narrow and defined band. In the vast majority of cases however, and certainly in the case of the US, currencies are allowed to float and central banks do not normally, and certainly not routinely, intervene to support their currency. Accordingly, the exchange rate for a particular currency against other currencies is determined by players, large and small, who are buying and selling the currency at any particular moment in time.

The mix of participants in the market is important and will affect different currencies to varying degrees. Some buyers and sellers deal in the market purely in support of international trade and are operating in the ‘goods’ market buying and selling currency to pay for merchandise being traded across national borders. Other dealers are buying and selling currencies in support of ‘portfolio investment’ and are trading in bonds, stocks and other financial instruments across national borders. Yet another group of currency traders are operating in the ‘money’ market and are trading short term debt across international borders.

As if this were not complicated enough, this mix of traders whether they are paying for imports, investing, speculating, hedging, arbitraging or simply seeking to influence exchange rates are also focusing their attention of a variety of different timeframes in their trading which will range from a matter of minutes to several years.

Against this background it is no wonder than predicting exchange rates is a complex business. Doing so however is vitally important since exchange rates influence the behavior of all of the participants in the market and, in today’s open market, also influence interest rates, consumer prices, economic growth, investment decision and so much else. It is for this reason that the forex market plays such a critical role in determining exchange rates.

Luxury home buyers are discovering that securing mortgage financing for a million dollar home is not as easy as in the past. The deterioration in the credit markets have made it increasingly difficult for buyers to obtain mortgage financing for high priced homes. Nevertheless, the markets have improved throughout the year, with rates and rate spreads falling and more lenders entering the market.  Nonetheless, rising rates could make today the final window of opportunity to purchase a home at an attractive price point, and with attractive financing.

A jumbo mortgage loan is a home loan in excess of the “conforming loan” limit; a limit is set by the Office of Federal Housing Enterprise Oversight (OFHEO), the regulator for both FNMA (Fannie Mae) and FHLMC (Freddie Mac). The current conforming loans limit is $417,000 ($625,000 in Alaska, Guam, Hawaii, and the U.S. Virgin Islands). The secondary market for jumbo loans, however, is limited primarily to mortgage lenders themselves who are backed by lines of credit provided by investment and commercial banks as well as large insurance companies. Because there is less of a secondary market for these larger loans, they tend to be somewhat more difficult to find and priced higher than conforming loans. This rate differential has ranged from .25% to 1.5% depending on the market environment.

In recent years, as the credit markets became increasingly loose, jumbo loans gained popularity. Many jumbo loans were made to investors and to other borrowers using “stated income” programs, now often referred to as “liar loans”, which required little in terms of income and asset verification. As the credit markets tightened, so did the underwriting of jumbo loans.  Full documentation is now mandatory and jumbo loan applicants must demonstrate credit scores of at least 720.  In addition, jumbo applicants must not show any 30-day mortgage or rental payment delinquency in the prior 12 months.

Three additional factors have created further disparities between conventional and jumbo loan underwriting. These are the required reserves, maximum loan to value, and debt to income ratios. Jumbo loans require that liquid assets equaling 12 months’ reserves reside in the borrower’s financial portfolio with three months’ of bank statements confirming the assets mandated. Conventional borrowers are normally required to prove only 2 months of liquid reserves.  Traditional loans can be obtained for up to 95% of the value of the home whereas many lenders cap jumbo loans at a 75-85% loan-to-value.  Lastly, the maximum debt to income ratio allowed for a conventional loan is 43% whereas a jumbo loan applicant must only demonstrate a maximum of 40% total combined debt.

In addition to increasingly stringent underwriting standards, the market for securitized jumbo mortgage pools has virtually disappeared.  Consequently, so did the loans.   No more than a year ago, it was difficult to find any fixed rate jumbo financing in the mortgage marketplace.  Most borrowers had to settle for adjustable rate loans in the hopes that they would be able to refinance in the future. Furthermore, the number of lenders in the jumbo market also declined, leading to increasingly higher rates.

The good news is that there are now more lenders in the jumbo loan marketplace.. 30-year fixed rate financing is available from select lenders and rate spreads on jumbo mortgage loans have declined relative to conforming loans. In December, 2008, we were seeing spreads on a 30-year fixed rate mortgage of almost 2%. Today, these same spreads are down to less than 1%.

In addition, as interest rates have fallen, rates on jumbo mortgage have declined.  Notice that both rates and spreads have started to increase modestly.

This is likely the best time in recent memory, and in the near future, to finance a new luxury home or to refinance your current jumbo mortgage. The low rates are due to the government adding liquidity to the market, primarily through Fed mortgage backed security purchases.  Rates would be significantly higher had we not had this intervention. The announcement that this practice will be discontinued in the first quarter of 2010, coupled with the likelihood of higher rates due to the falling dollar and dramatically increased government spending, make it likely that we will see higher rates next year. For luxury home sellers this creates a motivation to sell soon despite a relatively weak housing market. It also creates a window of opportunity for buyers to secure financing that may be at the most attractive rate levels we will see for the next decade.

As you can see, we believe that there is positive news for buyers considering rates have moderated and more programs are available in the jumbo space than there were a year ago. Existing borrowers can also take advantage of the changing market by refinancing their adjustable rate loans to fixed rates. While underwriting is indeed more stringent, financing is still available for qualified buyers. The outlook for the future may not be quite as attractive as an increasing rate environment will force many buyers to a lower price point, and a contracting economy leads more potential buyers to re-trench rather than buy that new home. The bottom line:  acting now is likely your best strategy if you are a buyer or a seller of a luxury home.

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