Loan limit changes for FHA and Conventional loans

The temporary loan limit increase for FHA and Conventional (Fannie Mae and Freddie Mac) loans is expiring on September 30th of this year.  In the highest cost areas of the US, this means a reduction in the loan amounts available from $729,750 to $625,500.  While many have said this is a needed change to reduce out dependency on Government sponsored financing for the housing market, others fear it will have negative effects on the current stumbling housing market.  In truth, the mortgages being originated are of the highest quality and best performing of our generation. They are either held as high performing and high yield returning assets on the federal books or sold with high profits for the federal government ( via mortgage bond pools guaranteed by FHA or Fannie or Freddie).  The argument that the government is backing poorly performing mortgages is groundless regarding newly generated loans. 

The downside to reducing these loan limits is far more damaging and pervasive than any government official's response we have seen so far.  The lack of understanding as to the damage to Main Street cannot be overstated.  Here are just some of the more important problems this will create:

                Interest rates on Jumbo loans, those above the $625,500, will be from .5% to a full 1% higher.  This alone will reduce borrower qualification as well as cause potential new buyers ( or move up buyers) to stay on the sideline. 

                On conventional loans with 20% or more for a down payment, qualification for a loan will allow debt to income ratios to be up to 50% and on Jumbo loans this number is 41%.... that is a 15% difference when translated to price affordability and qualification….  this will dramatically lower the eligible buyer pool for these price ranges. 

               Currently on conventional loans borrowers can put 10% down on an $800,000 house, $80,000, and qualify for a new mortgage.  When the new limit reductions take place, in this same $800,000 price range, jumbo lenders require a minimum of 20% down or $160,000 to qualify…. this will obviously wipe out a huge amount of potential buyers. 

                On FHA loans, the impact is even greater…. 

                                Borrowers can put down as little as 3.5% to qualify on an FHA loan.  That same borrower buying a $756,000 house would now have to put as much as $130,500 as a down payment as opposed to $26,500 under the old loan limits. 

                                FHA will allow debt to income ratios (when it makes good financial sense) up to 50% with the same 3.5% down payment.  Jumbo lenders will require 20% down and debt to income ratios of 41%... this will completely wipe out any FHA borrower looking above a $650,000 price.  As a high volume loan officer who has been lending for twenty years and who did not need FHA four years ago, I can tell you the impact here will be tremendous…. there are so many families who have had to use FHA to be able to afford to purchase a home or to move up from one house to another…. this will severely impact the market. 

                                FHA will allow borrowers with credit scores of 640 or above to qualify….  95% of jumbo lenders require credit scores of 720 or more… a few will go as low as 680 but then require much larger down payments and lower debt to income ratios…  with the financial duress that the common borrower has come under over the last four years, it is very common for credit scores to drop while at the same time the borrower to have been current on all payments for the last several years…. effectively rebuilding the credit score but not quite to the 720 level…. 

One of the key aspects of understanding the real estate market is the concept that all homes are connected.  If a $800,000 home sits on the market because the pool of buyers that qualify to purchase it are reduced ( in this case by our estimation 50%) then eventually they will reduce its asking price.  Probably to say $750,000.  Once that price is reduced… the home listed for $725,000 is not very attractive because a much nicer home is for sale for just $25,000 more… so they reduce their price to $675,000….  and so the dominos start….  ALL homes are connected….  ALL values will fall… it is not a matter of maybe… it is a certainty….  I live on this main street…. for twenty years….  I don’t make up these policies … I live them… lenders
(and the only ones left are the ones that did NOT do the subprime loans that got us into this mess) understand what is going on on the main streets of American…. We only wish our politicians did as well.  The loan limit reduction will be the single largest negative affect on our economy going forward.  If the intention is to continue to reduce overall debt in our society by reducing borrower's access to capital it will have that affect.  The rip off the band aid approach.  This will be a very painful period of time for our economy and for all of us.

Kent Kirkpatrick
Principal