REQUIRED READING: Since the onset of the financial crisis, the U.S. government has attempted to implement various programs aimed at stabilizing the real estate market and the overall economy. Most of these programs have been met with marginal success due to the complexity of the economy, the challenge of helping millions of homeowners and the lack of incentives for lender participation.
However, there was one program within the Economic Stimulus Act of 2008 that could be considered a genuine success: Freddie Mac and Fannie Mae's temporary increase in the conforming loan limits in designated ‘high-cost areas.’ In view of the current state of the economy and housing markets, it might make sense to take this program one step further and raise conforming loan limits to $729,750 in all parts of the country.
The maximum size of the mortgages that the government-sponsored enterprises (GSEs) can purchase is limited by Congress in order to minimize risks to taxpayers. Currently, the GSE loan limit – also known as the conforming limit – is set at $417,000 in most areas. Loans that come in above the conforming threshold are termed jumbo loans.Â Â
Due to the conforming loan limits, the jumbo mortgage market is serviced by private investors. But the securitization of jumbo loans has been virtually nonexistent for several years, requiring many jumbo investors to keep these mortgages in their portfolios. As a result, down-payment requirements that greatly exceed those of the GSEs and private investors usually have more stringent credit and debt-to-income requirements than the GSEs do.
The $417,000 conforming loan limit does not apply equally to all locations. In a small number of designated high-cost areas, the conforming loan limit is as high as $729,750 – or 175% of the conforming value of $417,000. These high-cost areas are the ones where the median home value exceeds the conforming loan limit. For example, the Greater New York and Washington, D.C., metropolitan areas and many parts of California fall into this category. In these high-cost areas, loans that fall in between $417,000 and $729,750 are referred to as ‘high balance conforming’ loans and are eligible to be part of the current program.
However, there are many qualified borrowers who live outside these high-cost areas – some only a few blocks outside of the designated sections – and they could potentially benefit from increased conforming loan limits. Very frequently, home prices in areas adjacent to high-cost areas are also high, but the homeowners living there have to seek mortgage funding from private investors. These investors generally require much larger down payments and charge higher rates of interest on their loans compared to Fannie Mae or Freddie Mac.
High-balance conforming loans still have rigorous underwriting standards, but they are not as strict as those required to qualify for a jumbo loan from a private lender. The stringent underwriting guidelines for jumbo loans greatly diminish the pool of eligible buyers for jumbo loans. Expanding the high-balance conforming loan program up to $729,750 nationwide would significantly increase the pool of eligible, qualified borrowers in the beleaguered purchase market. The influx of potential buyers would stimulate these markets and increase home sales.
Increasing the conforming loan limit to $729,750 nationwide would further spur jumbo home sales and allow many jumbo-mortgage holders to refinance into today's historically low rates. The money saved on mortgage payments could be used by the borrowers to make other purchases, and the cumulative effect of these purchases would have a substantial positive impact on the economy.Â
Further extending the high-balance conforming program would benefit not only the purchase market, but also the refinance market. There are many borrowers living outside high-cost areas that are paying jumbo mortgage rates for loans that fall between $417,000 and $729,750. Borrowers who formerly had jumbo mortgages with high rates would be able to refinance into lower-cost, high-balance conforming loans, saving thousands of dollars in the process and pumping money back into the economy.Â Â
While some may argue that allowing Fannie Mae and Freddie Mac to purchase larger loans would present an increased risk to the taxpayer, the GSEs are already doing this in certain defined areas. Plus, they are already lending above the conforming limit, which is evidence that the GSEs are comfortable with the underwriting standards on these loans. Further, loans that have been originated over the past two years are performing at vastly better levels than those originated during the bubble. No one is advocating that we go back to the days of no-documentation, no-income, no-asset loans.
Some critics of this plan may say that allowing the GSEs to lend in the jumbo market across the country would squeeze private investors from this space. Yes, that is true – the GSEs are absolutely able to provide funding at more favorable terms than most private investors can.
However, there are very few private investors currently active in the jumbo market. The beauty of raising the conforming limits is that it would be a temporary measure that could be rolled back at such a time when private investors are ready to re-enter the jumbo market. Increased nationwide conforming limits would simply fill the vacancy in this sector.
It is worth mentioning that many politicians and industry observers are currently advocating for shrinking or eliminating Fannie Mae and Freddie Mac altogether. However, the GSEs are necessary to keep the housing market going right now, and it is unrealistic to significantly reduce the size or scope of government lending at the present time without risking that the housing market would grind to a halt.
Making the conforming loan limit $729,750 nationwide would present a win-win situation. Unlike many other government initiatives intended to help the housing sector, this one would be readily accepted by both borrowers and lenders without any additional incentives. In light of the issues facing the housing market, now is an ideal time to implement this program.
John Walsh is president of Total Mortgage Services LLC, based in Milford, Conn. He can be reached at (203) 876-2200.