For roughly three years, the FHA as well as Fannie Mae and Freddie Mac (the GSEs) have been doing business with portions of the housing market priced higher than they have historically dealt with. The credit crisis made it difficult for borrowers to get mortgages not backed by the government, so the government stepped in to fill the void by raising the loan limits at which the GSEs and FHA can do business. With these loan limits set to decline at the end of September, it is worth examining the impact of this change to the housing market and the greater economy.
In May, the Department of Housing and Urban Development (HUD) published a report in which they estimated the volume of loans made in 2010 that were above the proposed lower limits. Likewise, the Federal Housing Finance Agency (FHFA) published a report in which the volume of GSE-backed mortgages impacted by the reduction in loan limits was tabulated. Analysts with the FHFA estimated that the dollar volume of GSE-backed loans above the proposed limits accounted for 5% of the GSE’s business and 3% of the total market volume in 2010. Likewise, the HUD report found that the dollar volume of FHA-backed loans above the proposed limits accounted for 6% of FHA loans by dollar volume in 2010 and 3% of its unit volume. However, the share of GSE-backed mortgages in a handful of states was significantly larger than the national picture. The share of GSE originations above the proposed limit was 12%, 6%, 4%, and 4% of GSE volume for DC, California, Connecticut and Massachusetts, respectively. The share of GSE lending by dollar volume for these four states was 22%, 14%, 10%, and 7%, respectively.
The high-cost areas that would be impacted by the decline in the conforming loan limits are geographically concentrated. In fact, the FHFA estimated that GSE support in just 250 counties and county-equivalent areas of the 3,334 nationally would be impacted by the decline in loan limits. The HUD estimated that FHA activity in 669 counties and county equivalents would be impacted by the increase in limits. (See map at bottom of article) The impact of the new limits may be limited geographically, but the effect on high-cost borrowers in these areas would be large. The Federal Housing Finance Agency (FHFA) estimated that borrowers who no longer qualify for the higher loans will face mortgage rates 50 to 75 basis points higher. Consequently, the impact could be large. For a homeowner with a 30-year fixed rate mortgage of $700,000 with a current rate of 5%, that is an additional $2,601 to $3,927 per year.
Faced with these higher borrowing costs, many would-be home buyers in affected loan range will be forced out of the market. While the share of FHA and GSE lending above the proposed limits appears small, because of the higher prices and geographic concentration, the economic impacts will be outsized. The loss of a home sale impacts the economy in 5 ways:
1) For each home sale, there is a direct effect on jobs and income in the real estate industry of roughly 9% of the sale price.
2) These funds are income that is in turn spent stimulating jobs and income in the rest of the economy. Thus the revenue to the real estate industry has a multiplier, assumed to be between 1.34 and 1.62 meaning that every dollar flowing to real estate results in 62 cents of additional spending or $1.62 total for the economy.
3) When a home is sold, new owners typically spend $5,331 on new furnishings and appliances.
4) As existing homes are sold, builders respond by expanding construction, which creates spending when the home is sold (note this does not include the value of the new home). [For more information on this methodology, visit this link]
5) Finally, local tax coffers benefit from each home sale through transfer taxes and recordation fees. [Local transfer tax rates from the Federation of Tax Administrators were used to estimate state-by-state transfer tax revenues]
Nationally, a 20% decline of sales volume in the portion of the market impacted by the decline in conforming limits and higher subsequent rates would result in a loss of roughly $1.9 billion in economic activity and $34 million in local taxes annually. By state, the largest impact by far would be in California, which would experience nearly a billion dollar decline in economic activity. Not surprisingly, states along the coasts with high density markets would experience the strongest impact, but states in the central US would be impacted by the decline in FHA volume as well.
Again, in most instances, these impacts would be concentrated in a small portion of counties in each state, magnifying both the economic impact and the loss of transfer taxes.
The housing market is in recovery mode and while a healthy market implies an expanded private presence in the mortgage market, the costs of what appears to be a small shift could have large impacts for local economies.
HUD analysis of the change in conforming loan limits included the chart below which depicts the counties affected by the possible decrease in FHA loan limits.