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November 22nd, 2011 (Modified on November 28th, 2011)

Strange compromise increases FHA loan limit

by Peter Miller


4-FHA-logoSomeone got a half a loaf on Capitol Hill last week with the passage of higher loan limits for FHA-backed mortgages. They also lost half a loaf with the failure to increase loan limits for conventional mortgages bought by Fannie Mae and Freddie Mac.

The result of the final compromises looks like this:

  • The largest FHA loan for a single-family home in a high-cost area within the lower 48 states is now back to $729,750–a figure which is back up from the previously “new” limit of $625,000 that began October 1. Yes, that’s right, the lower FHA limits were in place for all of about six weeks
  • The largest single-family mortgage that can be purchased by Fannie Mae and Freddie Mac remains unchanged at $625,500
  • You can borrow more with the FHA than with conventional financing

No one wins

This is a compromise which should satisfy no one. Here’s why:

Many conservatives are vehemently opposed to the general existence of the FHA because it provides mortgage insurance which can also be sold by the private sector. To them, the best use of the FHA would be its gradual elimination.

In fact, just before the vote, in a remarkable bit of timing, the conservative American Enterprise Institute promoted a paper by a Wharton economist which said the FHA program had insufficient reserves. This is true and something known to everyone. The new piece of information was the estimate that as much as $50 billion to $100 billion in taxpayer dollars might be needed to keep the FHA afloat.

On November 17, I dissected the Wharton analysis and said the failure of the program was grossly unlikely because “today’s FHA program is different than it used to be. Annual premiums have increased, seller-funded down payments are no longer allowed and the required down payment has increased.” In essence, the reserve should have required levels of capital by fiscal 2014–two years from now.

The next day, HUD came out with a rebuttal which said the AEI study “completely ignores our reforms to credit policy, risk management, lender enforcement, and consumer protections, which collectively represent the most sweeping in FHA history.”

And for good measure, HUD pointed out that, “According to our most recent quarterly report to Congress, endorsements in the 3rd Quarter added $1.7 billion in new funds to the capital reserve account, and the serious delinquency rate is well below year-earlier levels–this despite ongoing uncertainty in the housing market.”

Why increase the loan size?

If you believe the FHA has insufficient reserves and think it may need taxpayer money, why would you vote to increase the program’s maximum loan size? And if the existence of the FHA bothers you, why would you vote to make FHA loans more attractive than conventional loans in big cities and other high-cost areas?

That’s now the case because borrowers can get more funding through the FHA than with conventional loans being sold to Fannie Mae and Freddie Mac.

What happened to Fannie and Freddie?

So what happened to the proposal to also raise the loan limit for Fannie Mae and Freddie Mac financing? That proposal never made it out of the conference committee.

The final result is that the FHA can now loan more money to individual borrowers, a benefit so small as to be almost invisible–only 0.75 percent of all FHA borrowers take out mortgages of $500,000 or more.

Since the FHA loan limits have been extended through 2013, it might seem as though conventional loan limits are now in place for the next two years. Wrong. Look for “corrective” legislation to change the gross “unfairness” impacting the “middle class” who pine for bigger loans from Fannie Mae and Freddie Mac.

Ironically, builders, lenders and brokers must now promote the FHA to sell the bigger mortgages they want. There must be teeth grinding somewhere.

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