photo © 2006 Franco Folini | more info (via: Wylio)After several months of speculation that conforming loan limits would be reduced in 2012, FHFA released the official numbers last night. A similar announcement was already made about FHA loans. This another significant step in the declared effort to limit future US Government involvement in the mortgage industry.
Economists and regulators have so far speculated that the broader market impact will be insignificant. However, in a case study below, we will see that at the individual level, property transactions in the affected price ranges will assuredly notice a difference.
Quick Background
At the beginning of 2008, we found the market throat-deep in the mortgage meltdown, and in the early stages of the housing crisis. Conforming loan limits were set nationally at $417,000. Congress passed the Housing and Economic Recovery Act (HERA) of 2008, bumping the conforming loan limit celiling to $625,500 for select ‘high cost’ areas, as defined by median house value in 2007. Some counties hit the max, others landed somewhere between the old limit and the new one.
But a few months later the Economic Stimulus Act (ESA) of 2008 took over with a more liberal approach, and the new ceiling was raised to $729,750. ESA is set to expire on before October 1, 2011. The HERA limits will still be in place.
San Francisco Bay Area mortgages – What’s the Impact?
For most parts of the country, the conforming loan limit is, and has been $417k since 2005. That is not going to change.
Seven Bay Area counties currently have ‘high cost’ conforming loan limits at the national maximum of $729,750. These are:
- Alameda County
- Contra Costa County
- Marin County
- Napa County
- San Francisco County
- Santa Clara County
- San Mateo County
Impact to the Market and to Buyers and Sellers
For the last year’s worth of mortgage data, approximately 50k loans would have fallen in this ‘used-to-be-conforming-now-jumbo’ range. Roughly 30k of those are California transactions, and though the data didn’t get more specific than this, it’s safe to assume that a significant number of those were from Bay Area real estate transactions. Market-wise, economists say this will not have a significant impact.
But for an individual transacting in the affected sector, the impact will be substantial.
Taking a single price point as a case study:
- Purchase price $787,500, 20% down
- Loan amount $630,000 (just over the new conforming limit)
- Assuming a 0.500% rate increase for jumbo rates relative to conforming
- Assuming a .04% qualifying ratio limit decrease for jumbo relative to conforming
- As a conforming loan, assuming 4.750%, normal tax and insurance figures, the monthly housing payment in this scenario would be about $4106. Conforming loans allow for up to 45% of gross monthly earnings to be used to service recurring obligations, so the minimum income needed to qualify in today’s environment would be $9125
- As a jumbo loan, assuming 5.250%, the same tax and insurance figures, the monthly housing payment in this scenario would be about $4299. Jumbo loans allow for up to 41% of gross monthly earnings to be used to service recurring obligations, so the minimum income needed to qualify after October 1 would be $10,485.
There’s a squeeze play at work here. It will take 14.9% more income to qualify for the same sized loan, because the costs are higher, and so are the benchmarks for qualification. Just like that. Overnight.
In this case, a borrower would likely find another $4,500 to put down on the house and keep the loan under conforming limits. A keen understanding of the marginal costs of borrowing would provide that incentive. But what if the loan amount would have been $640k? $650k? $675k?…. $700k or $725k?
Simply put, there’s a bandwidth of market activity that will be disrupted by these changes. Along with the changes to FHA loan limits, any property selling for between $650k and $912k will have a buyer pool who has seen their borrowing options change. Faced with a different set of options:
- Some will put more money down, keep the loan conforming. But not all will have the capital to do so.
- Some will digest the higher jumbo loan costs. But others will reduce their top price to keep the payment from increasing.
- Some will simply not be able to qualify for financing the home they wanted.
Do not Assume the Effective Date is a Safe Deadline
FHFA has announced the change to be effective October 1, 2011. However, even before the announcement was made, last Friday we learned that a major national lender was ceasing all applications above $625,500 for conforming loans. For whatever reason, they’ve decided that the don’t want to participate in this sector for the final three months. Other lenders could follow suit. Maybe today, maybe tomorrow. Maybe not until September. But you certainly don’t want to be too patient here. Rates are presently low as it is, so the risk of waiting is only increasing, and seems to exceed any potential benefits.