Beginning on Saturday, the maximum limit for loans that can be backed by government-related entities will decline modestly in many of the nation’s most expensive housing markets. Over the next few weeks it’s worth watching what happens to sales of homes priced between the new and old limits. Here’s a primer for those who are just tuning in.
What’s happening? When the mortgage market melted down in 2007, a big chunk of the mortgage market—the private market for buying and securitizing mortgages—stopped functioning. This meant that most loans getting made were “conforming” loans, or those eligible for government backing from Fannie Mae, Freddie Mac, and federal agencies like the Federal Housing Administration.
Anything that the government couldn’t guarantee—primarily “jumbo” mortgages that exceed the conforming loan limit of $417,000—had to be held on banks’ balance sheets and those borrowers saw a big jump in borrowing costs.
To address this, Congress and the Bush administration in 2008 expanded the maximum size for loans that Fannie, Freddie and the FHA could guarantee. The limits vary depending on local home prices and rise to as high as $729,750 in New York, Los Angeles, Washington, D.C., and other high cost markets. The limits were initially set to fall modestly at the end of 2008. But Congress passed a series of one-year extensions last year and the year before to keep the higher limits in place. Efforts to extend the limits through 2012 haven’t gotten much traction in Congress this year, which means that on Saturday, the maximum limits will fall, though not all the way back to $417,000.
Where will the limits fall? There are actually two different sets of limits—one for FHA-backed loans, and another for “conforming” loans that can be sold to Fannie and Freddie. The conforming loan limits will fall in around 250 counties on a sliding scale. The maximum loan size will fall to $625,500, from $729,750, but other counties with loans above the $417,000 floor will also see declines. These roughly 250 counties account for about one quarter of all housing stock. (And in Hawaii, the loan limits are falling from an even higher level.)
The FHA limits will fall in around 600 counties accounting for around 59% of all homes in the U.S., according to the National Association of Home Builders. The limits range from $271,050 to $625,500. In some places, the FHA limit will drop further than the conforming limit. In San Bernardino, Calif., for example, the FHA limit will drop from $500,000 to $355,350, while the conforming limit will fall to $417,000.
Why does this matter? Loans that aren’t eligible for government backing tend to carry higher rates and, more importantly, tend to require down payments of at least 20%. Because the FHA allows borrowers to make minimum down payments of just 3.5%, the jump from an FHA-backed loan to a jumbo loan could be one that some borrowers can’t make.
If you live somewhere where all the homes are below $300,000, these changes won’t matter. But for people who live in places where homes are pricier, tougher lending standards and higher borrowing costs could reduce the potential pool of buyers. That, in turn, could put pressure on prices.
Take San Diego County, where one in 12 loans over the past year fell in between the new and the old loan limit, assuming a 10% down payment. Many of those sales might have happened anyway, but in some of them, buyers might not have been able to qualify or wouldn’t have had a 20% down payment. (Remember that the “trade-up” market remains frozen largely due to the steep loss many households have suffered in home equity.)
Some economists have warned that shrinking the pool of potential buyers in specific markets at a time when there’s an oversupply of homes is too risky given the weakness of the broader market.
Then why is the government letting loan limits fall? The government currently backs nine in 10 mortgages, and this is seen as a small but important step in testing the ability for private investment to return to mortgages.
Many people in Washington, including the Obama administration and congressional Republicans, support letting the limits fall in order to modestly shrink the government’s role in the housing market. In essence, these high-cost communities will serve as a “pilot” for what happens when the government takes a toe out of the mortgage market.
As many see it, the private market for securitized loans won’t ever return if the government continues to subsidize the vast majority of mortgages.
Can banks handle the uptick in loan volume? A Federal Reserve study released last week showed that just 1.3% of loans backed by Fannie and Freddie last year wouldn’t be eligible under the lower limits. Banks will certainly take on the new business, but the real question is, at what price?
The same paper showed that had the lower limits been in place last year, banks would have had to increase by 50% the amount of jumbo loans they made last year. That would mean banks would have increased by 20% the volume of all loans held on their books. The report concluded that those numbers are “substantial and suggest that at least some of these loans would not have been originated or would have been originated only at higher prices.”
Will Congress bring back the higher limits? So far, Congress hasn’t taken up any of the bills designed to keep the limits at their higher levels. It’s possible, of course, that efforts to revive the higher limits will get more attention later this year, but for now, Congress seems ready to let the limits slide.