Jumbo mortgage squeeze: how it will affect home pricesby Peter Miller
In 2008, with the housing market in tatters, the government passed such bills as the Economic Stimulus Act of 2008 (ESA) and the Housing and Economic Recovery Act of 2008 (HERA). The basic purpose of these laws was to increase the amount of mortgage financing we defined as “conventional,” from $417,000 to as much as $729,750 in “high cost” areas within the 48 contiguous states.
This new definition of a jumbo loan–now financing above $729,750 and not just in excess of $417,000–meant that we lowered the cost to buy a mini-mansion. This happened because there’s generally a premium for “jumbo” financing, say an interest rate which is .50 percent higher than the rate for conventional loans.
Smaller loan sizes=less upward pressure on home prices
In other words, imagine that under the old system you could get financing for $415,000 with mortgage rates at 5 percent. The monthly cost for principal and interest over 30 years would be $2,228. Or, imagine that you absolutely had to borrow $420,000. It’s only $5,000 more but now you’re in jumbo territory. If mortgage rates today are at 5.5 percent, the monthly cost will be $2,385.
Rather than pay an additional $157 per month to borrow $5,000, the wiser decision would be to come up with a few thousand dollars more to close the deal or to simply buy a less-expensive home.
The catch with the 2008 loan limit increases is that they were supposed to be temporary…and that brings us to 2012.
The problem is that while lower loan limits are politically attractive, they have a byproduct: people will not want to borrow above the loan limit and pay extra for jumbo financing. Therefore, buyers will bid less for properties in an effort to get mortgage balances below the conventional loan limit. And bidding less for properties also means less pressure for home values to rise.
Lower loan limits
In February, the Treasury Department outlined a plan to reform the mortgage marketplace. A key area of focus was the reduction of mortgage loan limits:
The conforming loan limit is the maximum size of a loan that Fannie Mae and Freddie Mac are allowed to guarantee In order to further scale back the enterprises’ share of the mortgage market, the Administration recommends that Congress allow the temporary increase in limits that was approved in 2008 to expire as scheduled on October 1, 2011 and revert to the limits established under HERA. We will work with Congress to determine appropriate conforming loan limits in the future, taking into account cost-of-living differences across the country. As a result of these reforms, larger loans for more expensive homes will once again be funded only through the private market.
The catch here is that not everyone wants lower limits. For instance, if you were a lender, broker or tax collector, lower limits would likely mean smaller checks. If you live in California, Massachusetts, the Washington, DC area or any other high-cost region of the country, it might suddenly become more difficult to finance homes in the upper brackets.
$625,500 may not happen
Under orders from Congress, Fannie Mae and Freddie Mac are supposed to reduce their maximum loan size from $729,750 to $625,500 on October 1, 2011.
The view here–despite a variety of white papers, agreements, news reports and promises to the contrary–is that the loan limits we have now will generally remain in place to avoid undermining the market for high-cost properties in lots of congressional districts. The exception will be FHA mortgages, where maximum loan limits are still likely to fall in an effort to make such financing less competitive with private mortgage products.