Revised Loan Limits Have Uneven Effect; Private Market Response Unknown

When Congress temporarily raised the maximum loan size eligiblernfor mortgages guaranteed by FHA or by the government sponsored enterprisesrn(GSEs) Fannie Mae and Freddie Mac in 2009, it was its stated intention to ensurernthe availability of mortgage credit even when private financing might, in thernlight of the evolving mortgage crisis, withdraw from the market.  Those temporary limits expired on October, creatingrna lot of uncertainty about what might happen to borrowers no longer able tornobtain conventional or FHA mortgages.</p

New York University’s Furman Center for Real Estate andrnUrban Policy recently published a white paper which explores the potentialrnimplications of the reductions which, as it says, are merely the first step inrna long-term policy goal to reduce government’s role in the mortgage system andrnit will be “the canary in the coal mine” that will indicate how wellrnprivatization will work. </p

Even after the limits were raised a small number of loansrnstill exceeded them and these “jumbo loans” were essentially the only loansrnbeing originated without government or GSE backing.  They differed in a number of significant waysrnfrom the market for GSE or FHA-backed loans. rnBecause they lacked the government guarantee, they typically have higherrninterest rates and require higher down payments than FHA and sometimes GSErnloans.  For those reasons many higher endrnloans included under the new limits might not have qualified for a mortgage ifrnthe conventional/FHA options were not available.  They were also financed differently.  Since the financial crisis the secondary marketrnfor private label (non-government backed) mortgages virtually disappeared andrnlenders had to retain virtually all jumbo loans they originated in their ownrnportfolios, bearing all of the risk.  </p

The principal questions arising from the change in loanrnlimits are how many originations will be pushed into the jumbo mortgage categoryrnbecause of the revisions and how will the private market react to and absorbrnthose loans?   </p

The authors of the paper found that the roll-back of loanrnlimits affected individual metropolitan areas differently depending on localrnhousing prices.  In 214 areas with 29rnpercent of the population neither the GSE or FHA limits changed.  In 152 metro areas with 71 percent of thernpopulation the FHA limit was reduced and in 50 of these, primarily on the tworncoasts, the GSE limits also decreased. rnBecause of different formulas used to compute the limits there can bernsubstantial difference between an FHA limit and a higher GSE one.  For example, in Las Vegas the GSE limitrnremained at $417,000 while the FHA limit dropped from $400,000 torn$287,500.  In Stockton, California bothrntypes of loans carried a limit of $488,750 before October 1 and now the GSErnlimit is $417,000 while the FHA limit is $304.750. </p

To estimate the possible impact of the changes to thernhousing market, NYU researchers overlaid the loan limit changes onto homernpurchase mortgage origination data for individual areas in 2009, the mostrnrecent year available.  Nationwide theyrnfound that only about 14,000 conventional purchase mortgage and 4,000 FHA loansrnissued in 2009 were for amounts that would put them outside the newrnlimits.  Another 13,000 FHA loans wouldrnno longer be eligible for FHA financing but were of a size that could stillrnqualify for conventional financing. rnThese two groups together represent 1.5 percent of all 2009 homernpurchase originations and 3.6 percent of all dollars lent to owner-occupierrnbuyers in metropolitan areas.  Thernauthors conclude that, even if FHA or GSE backing is unavailable to that numberrnof borrowers and they are unable to find an alternative way of financing the “impactrnon home prices is likely to be minor and confined to a very small segment ofrnthe housing market.”</p

The same analysis of mortgages for refinancing also foundrnslight impact.  Only about 0.7 percent ofrnmortgages used to refinance first liens were conventional or FHA loans with arnsize and location that would disqualify them for a GSE or FHA guarantee orrnboth.</p

However, when certain housing markets are isolated -rnespecially those in California and the Northeast, the changes have thernpotential to be more disruptive.  In SanrnJose, for example, about 9 percent of all purchase originations would have beenrnineligible today, the highest found.  Inrnthe San Francisco Bay area and San Diego about seven and five percentrnrespectively would no longer qualify. rnMany middle-sized areas are also affected, some solely by a reduction inrnFHA limits, others with high numbers of loans that would not qualify underrneither limit.</p

While the numbers of loans now falling outside the government-backedrnloan realm is small it is significant when compared to the volume of jumbornloans that the private sector has been handling. The study estimates that therernwill be a need for approximately 7,900 loans totaling $4.67 billion to fill thernFHA gap, 41,800 loans worth $27,431 billion no longer eligible for conventionrnfinancing, and 75,000 loans worth $71.61 billion that did not meet loan limitsrneven before the October revisions (the 2009 jumbo market.)  This means that private lenders need the capacityrnto absorb 56 percent more loans than they did in 2009 and a 38 percent increasernin the dollars lent. </p

Few of the newly displaced FHA borrowers will be able tornqualify for conventional loans even if their loans meet the GSE limits because ofrninsufficient down payments or credit scores. rnMost will have to apply for smaller loans to purchase less expensivernhomes or delay their purchases and continue renting for a period of time. </p

Private lenders will probably be more likely to fill the gaprnin conventional lending as these borrowers tend to be higher income and morernlikely to have sufficient credit scores and assets to make the down payments necessaryrnto qualify for jumbo market financing.</p

The authors note that a broad array of policymakers arernseeking to hand a larger share of the mortgage market over to the privaternsector so Congress will probably have to reduce loan limits even further.  These first loan limit reductions will testrnthe ability of the private sector to accommodate a relatively large increase inrndemand.</p

It is possible, they say, that the private sector will notrnstep up. It might be unwilling to devote significant portfolio capacity tornmortgage debt or to specific types of mortgages.  This would be evidence that the GSE’s and FHArnare still serving a broad function and that further massive changes should berndelayed.  Even if the private sector doesrnrespond effectively to this round of reductions, that is not grounds to assumernthey will respond to subsequent rounds especially as these would increasingly involvernmore moderately priced loans in less affluent areas of the country.</p

If the expansion of private sector lending occurs primarilyrnthrough portfolio lending without a revived private label secondary market, therncapacity of bank portfolios to absorb further lending should still loom as arnconcern.  If the private sector secondaryrnmarket does re-emerge to financing an expansion of jumbo lending this wouldrnsuggest that private lending could comfortably be scaled up to meet additionalrndemand.</p

Other factors such as an increase in home prices or homernsales volume can also affect the demand and how well the private sector is ablernto meet it.  The authors note that it isrncritical to evaluate this before the Congress chooses to enact further pullrnbacks of government-backed mortgage eligibility.

All Content Copyright © 2003 – 2009 Brown House Media, Inc. All Rights Reserved.nReproduction in any form without permission of MortgageNewsDaily.com is prohibited.