Revised Loan Limits Have Uneven Effect; Private Market Response Unknown
When Congress temporarily raised the maximum loan size eligible for mortgages guaranteed by FHA or by the government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac in 2009, it was its stated intention to ensure the availability of mortgage credit even when private financing might, in the light of the evolving mortgage crisis, withdraw from the market. Those temporary limits expired on October, creating a lot of uncertainty about what might happen to borrowers no longer able to obtain conventional or FHA mortgages.
New York University's Furman Center for Real Estate and Urban Policy recently published a white paper which explores the potential implications of the reductions which, as it says, are merely the first step in a long-term policy goal to reduce government's role in the mortgage system and it will be "the canary in the coal mine" that will indicate how well privatization will work.
Even after the limits were raised a small number of loans still exceeded them and these "jumbo loans" were essentially the only loans being originated without government or GSE backing. They differed in a number of significant ways from the market for GSE or FHA-backed loans. Because they lacked the government guarantee, they typically have higher interest rates and require higher down payments than FHA and sometimes GSE loans. For those reasons many higher end loans included under the new limits might not have qualified for a mortgage if the conventional/FHA options were not available. They were also financed differently. Since the financial crisis the secondary market for private label (non-government backed) mortgages virtually disappeared and lenders had to retain virtually all jumbo loans they originated in their own portfolios, bearing all of the risk.
The principal questions arising from the change in loan limits are how many originations will be pushed into the jumbo mortgage category because of the revisions and how will the private market react to and absorb those loans?
The authors of the paper found that the roll-back of loan limits affected individual metropolitan areas differently depending on local housing prices. In 214 areas with 29 percent of the population neither the GSE or FHA limits changed. In 152 metro areas with 71 percent of the population the FHA limit was reduced and in 50 of these, primarily on the two coasts, the GSE limits also decreased. Because of different formulas used to compute the limits there can be substantial difference between an FHA limit and a higher GSE one. For example, in Las Vegas the GSE limit remained at $417,000 while the FHA limit dropped from $400,000 to $287,500. In Stockton, California both types of loans carried a limit of $488,750 before October 1 and now the GSE limit is $417,000 while the FHA limit is $304.750.
To estimate the possible impact of the changes to the housing market, NYU researchers overlaid the loan limit changes onto home purchase mortgage origination data for individual areas in 2009, the most recent year available. Nationwide they found that only about 14,000 conventional purchase mortgage and 4,000 FHA loans issued in 2009 were for amounts that would put them outside the new limits. Another 13,000 FHA loans would no longer be eligible for FHA financing but were of a size that could still qualify for conventional financing. These two groups together represent 1.5 percent of all 2009 home purchase originations and 3.6 percent of all dollars lent to owner-occupier buyers in metropolitan areas. The authors conclude that, even if FHA or GSE backing is unavailable to that number of borrowers and they are unable to find an alternative way of financing the "impact on home prices is likely to be minor and confined to a very small segment of the housing market."
The same analysis of mortgages for refinancing also found slight impact. Only about 0.7 percent of mortgages used to refinance first liens were conventional or FHA loans with a size and location that would disqualify them for a GSE or FHA guarantee or both.
However, when certain housing markets are isolated - especially those in California and the Northeast, the changes have the potential to be more disruptive. In San Jose, for example, about 9 percent of all purchase originations would have been ineligible today, the highest found. In the San Francisco Bay area and San Diego about seven and five percent respectively would no longer qualify. Many middle-sized areas are also affected, some solely by a reduction in FHA limits, others with high numbers of loans that would not qualify under either limit.
While the numbers of loans now falling outside the government-backed loan realm is small it is significant when compared to the volume of jumbo loans that the private sector has been handling. The study estimates that there will be a need for approximately 7,900 loans totaling $4.67 billion to fill the FHA gap, 41,800 loans worth $27,431 billion no longer eligible for convention financing, and 75,000 loans worth $71.61 billion that did not meet loan limits even before the October revisions (the 2009 jumbo market.) This means that private lenders need the capacity to absorb 56 percent more loans than they did in 2009 and a 38 percent increase in the dollars lent.
Few of the newly displaced FHA borrowers will be able to qualify for conventional loans even if their loans meet the GSE limits because of insufficient down payments or credit scores. Most will have to apply for smaller loans to purchase less expensive homes or delay their purchases and continue renting for a period of time.
Private lenders will probably be more likely to fill the gap in conventional lending as these borrowers tend to be higher income and more likely to have sufficient credit scores and assets to make the down payments necessary to qualify for jumbo market financing.
The authors note that a broad array of policymakers are seeking to hand a larger share of the mortgage market over to the private sector so Congress will probably have to reduce loan limits even further. These first loan limit reductions will test the ability of the private sector to accommodate a relatively large increase in demand.
It is possible, they say, that the private sector will not step up. It might be unwilling to devote significant portfolio capacity to mortgage debt or to specific types of mortgages. This would be evidence that the GSE's and FHA are still serving a broad function and that further massive changes should be delayed. Even if the private sector does respond effectively to this round of reductions, that is not grounds to assume they will respond to subsequent rounds especially as these would increasingly involve more moderately priced loans in less affluent areas of the country.
If the expansion of private sector lending occurs primarily through portfolio lending without a revived private label secondary market, the capacity of bank portfolios to absorb further lending should still loom as a concern. If the private sector secondary market does re-emerge to financing an expansion of jumbo lending this would suggest that private lending could comfortably be scaled up to meet additional demand.
Other factors such as an increase in home prices or home sales volume can also affect the demand and how well the private sector is able to meet it. The authors note that it is critical to evaluate this before the Congress chooses to enact further pull backs of government-backed mortgage eligibility.