How Will Lower Loan Limits Affect Home Buyers
The mortgage market is set to take another hit. Come October 1, 2011, conforming and FHA loan limits are set to drop significantly. Higher loan limits that were set a few years ago are expiring. The level at which the government backs “conforming loans,” will decrease from $729,750 to $625,500 in high cost areas.
Conforming loans come with the lowest interest rates available to qualifying borrowers. Conforming loans, also called conventional loans, are loans that can be purchased by Fannie Mae or Freddie Mac and then sold on the secondary market. Borrowers financing a loan for more than the conforming loan limit will have fewer options. They can expect to pay a higher interest rate and have to come up with a much larger down payment for a purchase mortgage.
It is not only high-cost areas that are affected; other areas will see a significant drop, too. For example, Hampshire County in West Virginia will see a 43.9% drop in its FHA limit, Hawaii County, Hawaii and Valley County, Idaho will also see a drop of more than 40%. Plenty of other places across the country, from Manatee County, Florida, to San Juan County, Colorado will see drops. View a listing of the new FHA limits Potential Changes to FHA Single-Family Loan Limits beginning October 1, 2011 from Implementation of the Housing and Economic Recovery Act of 2008 (PDF), by viewing the table that starts on page 7 of the document. The new Fannie Mae and Freddie Mac limits can be viewed on the FHA site.
3.5% Down vs. 20% Down
FHA loans require only a 3.5% down payment, making them a very attractive option. Conventional purchase loans, on the other hand, generally require a 20% down-payment. Since the mortgage market collapse, 100% financing options have disappeared. The low down-payment requirement, along with higher loan limits, are the reasons that FHA purchase loans have grown from about 5% of the market to about 40%, at their peak. The market share of FHA refinance loans has also grown, in part to the fact that the FHA will loan up to 96.5% of a property’s value.
The federal government raised the loan limits a few years ago, at the peak of the economic crisis, to make it easier for borrowers to access loans. With the limits set to drop, more borrowers will be pushed into jumbo loans, the only kind of loan available for a dollar amount greater than the conforming loan limit. Jumbo loan borrowers have to meet stricter lending requirements, pay a higher interest rate, and pay higher fees. Jumbo loans require a 20% down payment. Borrowers no longer able to take out an FHA loan, because the loan exceeds the new, lower limits, will have to come up with a down payment of 20% instead of 3.5%.
The difference is significant for a $200,000 home. A 3.5% down payment is $7,000 and a 20% down payment is $40,000. For a home worth $400,000 or $600,000 the required 20% is $80,000 and $120,000, respectively, compared to $14,000 and $18,000 at 3.5%. That is a world of difference. Borrowers who are unable to come up with a 20% down payment will have to find a cheaper home that fits within the limits. This will add more pressure to the already teetering housing market.
The lower limits are being put into place for a reason. The rise in FHA market share, combined with the Fannie Mae and Freddie Mac’s expanded market share has led to a situation where the vast majority of the mortgage market is in government guaranteed or backed hands. Given the $150+ billion expected loss to taxpayers due to Fannie and Freddie, it is prudent to reign in their market share. The desire to cut back the government presence and exposure, so private lending can grow, is the key reason that loan limits are being cut.
Fed Chairman Weighs In
“As far as Fannie Mae and Freddie Mac are concerned, there is a tradeoff between supporting higher-priced homes and weaning the housing finance system off of unusual limits it was put under during the crisis,” Bernanke said. “I understand the private sector is taking at least a significant number of the jumbo mortgage market but at a higher cost.” Whether buyers will bear the higher costs or will be forced out of the purchase market is the unanswered question for all of us and for Chairman Bernanke. “I don’t have an answer other than to say that we have to get our housing finance system back into working order,” Bernanke said.
Although the long-term effects of lowering the loan limits may be positive, the immediate effects are likely to be negative. Private lending is not likely to jump in immediately and fill the gap created by the loans that will no longer meet FHA or Fannie and Freddie standards. At a time when the overall economy is weak, adding another negative factor is not going to help the economy recover, especially one that affects an area as important to the economy as the housing sector.
“The housing market stands on a three-legged stool: employment, consumer confidence, and the ability of borrowers to obtain financing,” said John V. Pinto, owner/real estate broker in the Silicon Valley and former President of the Real San Jose Real Estate board , known today as the Santa Clara County Association of Realtors. “Unemployment is lingering at high levels and consumer confidence is low. Making it harder for borrowers to obtain financing weakens the the third leg of an already wobbly stool.”
“The market is flooded with foreclosures,” Pinto said. “These need to be cleared out, so the housing market and property values can stabilize. Instead, the government is placing hurdles in front of potential buyers. The new rules are anti-first-time home buyer and also hurt past homeowners with dings on their credit. They both will have a harder time buying a home. Fewer eligible buyers precipitates greater vulnerability and increases pressure for further declines in real estate values, which creates even more foreclosures and short-sales,” Pinto said.
The lower loan limits don't only harm home-buyers or people looking to refinance, Pinto points out. "The market forces are lining up against tenants and for landlords. The harder it is to buy a home, the more the rental imbalance." Renters can expect to face higher costs for renting, according to Pinto.
National Association of Home Builders
Pinto’s views are echoed by a study released by the National Association of Home Buyers NAHB. The NAHB commented on the study. “The lower limits will place a constraint on home buying in high-cost housing markets, such as those along the coasts and in California. It is the last thing we need in a housing market that is still struggling to get back on its feet,” said NAHB Chairman Bob Nielsen, a home builder from Reno, NV.
“The downward pressure on prices could extend beyond the homes directly affected by the lower limits, the study warns, because first-time and trade-up home sales are interrelated,” Nielsen said.
According to the NAHB statement, “Lowering the limits will take an even bigger toll on homes eligible for FHA-insured financing...Under present law, 8.32 million owner-occupied homes are priced above the existing FHA loan limits. Under the changes set to take place on Oct. 1, an additional 3.87 million owner-occupied homes will surpass the limit, bringing the total number of homes ineligible for FHA-insured mortgages to 12.2 million.” Along with 5 million homes the NAHB estimates will no longer be available for Fannie and Freddie funding, there will be 17.2 million homes ineligible for government funding or guarantees.
A study from George Washington University (GWU) states that the decrease in loan limits will have a limited effect on relatively few borrowers. While not ignoring Fannie and Freddie, the GWU study centered on the FHA. The GWU study concluded that FHA loan limits need to be reduced, to account for the drop in property values since the bubble burst, to limit the FHA’s market share and return to it’s basic goal of helping first time, low-income, and minority homeowners.
Whether the effect of lowering the loan limits for Fannie, Freddie, and the FHA will be deep, of course, is an open question. It seems apparent that even the most optimistic view expects some negative short-term effects. Given the importance of consumer confidence to the ability to commit to buying a home, lowering the loan limits seems destined to be another stumbling block in the way of a housing sector recovery. If you look to buy a home in the near future, close your loan before the new limits go into effect, if you are in an area where the limits are dropping.
Congress could take steps to stop the loan limit decrease from taking place, but that pre-supposes a Congress that is capable of action. From what we see now, Congress seems to be able only to tie itself and the entire country in knots, unable to solve a problem as serious as the debt ceiling. Only an optimist would be confident that Congress is willing and able to take the necessary steps to help homebuyers and the housing sector.