How an Increase in Mortgage Limits can Impact Real Estate

by : Donald Plunkett

Fannie Mae and Freddie Mac, two housing finance companies that have the implicit backing of the United States government, presently limit the mortgages they buy in the lower 48 states to a maximum size of $417,000. Alaska and Hawaii loans can be as high as $625,500. They also have a number of other requirements such as documented income, employment verification, and many others. A loan that does not meet the strict guidelines is considered to be non-conforming and is not eligible to be purchased by Fannie Mae and Freddie Mac. This includes all "jumbo" mortgages which are mortgages greater than $417,000. Loans are certainly available for these borrowers, however, it must come from other sources of capital such as banks, credit unions, and mortgage companies that often sell large pools of mortgages to investors. Historically, these loans would require rates to be perhaps ¼% higher than conforming rates. However, as investors lost a lot of money investing in mortgage backed securities that ended up being of poor quality, they immediately required higher rates of return on new mortgages. Now, jumbo loans are averaging about 1% higher interest rates than conforming mortgages.

Some politicians and regulators feel that by raising the loan size limit placed on Fannie Mae and Freddie Mac to as high as $729,500 in high cost areas, the value of property would be positively affected, especially in high cost states like California. This is virtually an economic certainty. Residential real estate historically sells based on debt ratios. Buyers were expected to spend no more than 30-40% of their gross income on housing. As such, any drop in rates would yield more buying power for each buyer that was taking out a loan. With a lower interest rate, a person can pay more for a house yet keep the same monthly payment. Giving buyers and current homeowners who want to refinance the access to lower cost capital will serve as an offsetting factor to downward price forces such as too much supply, higher levels of foreclosures, or home prices that don't reflect local incomes. The markets most affected by an increase in conforming mortgages would include: San Diego, San Jose, Riverside, Orange County, Los Angeles, San Francisco, and Sacramento.

The downside of raising the limits should also be considered. For one, if you cause the value of real estate to increase based on lower interest rates, you make housing less affordable to people like cash buyers that don't care about obtaining a loan. Additionally, Freddie Mac and Fannie Mae have faced a number of operational and accounting problems in recent years, and they also do not have a history of expertise in the jumbo loan market. Finally, you need to ensure that you are not heavily focused on the size of conforming loans while ignoring other factors such as attracting additional investment capital to the mortgage backed securities market or dealing with people that simply cannot qualify for a loan in the house they are in because they have negative equity or do not have the income to justify owning the home.