In early September, the Federal Housing Finance Agency (FHFA), the entity that oversees Freddie Mac and Fannie Mae, gave notice that it would revise the conforming loans limits in an attempt to stimulate the private sector, specifically the private mortgage securitization (PLS) market. Though any reduction in the loan limits is expected to be relatively modest, it could have more far reaching impacts at the local level and for the affected borrowers.
Each year, the FHFA adjusts the national conforming loan limit which defines the space within which Fannie Mae and Freddie Mac can finance mortgage. The national limit is $417,000, but that varies by county and can increase to $625,500 in high cost markets. The FHA’s limits, which range from $261,050 to $725,750, are based off of the conforming limit so the FHFA’s actions would impact FHA borrowers as well.
NAR Research estimates that if the national conforming limit were lowered to $400,000, roughly 145,000 total conforming mortgages and 49,000 conforming purchase mortgages would have been impacted in 2012 . If the FHA limits were also revised, the impact would be larger by roughly 15,000 and 7,000 borrowers, respectively. The total number was inflated due to the refinance boom in 2012. However, strong price growth in 2013 has likely pushed more home buyers toward the conforming limits. Most estimates have the impacted volume at roughly 2-5% nationally.
While the estimate of the national impact may appear relatively small, the change could have a significant effect at the local level. As depicted in the map below, the impact goes beyond the high priced markets on the coasts and would affect some smaller communities in the Midwest and South. Furthermore, several of the markets in the top 25 most impacted are in formerly distressed areas (e.g. Atlanta, Sacramento, Riverside-San Bernadine, Oakland, Tampa, and Phoenix). These are areas where FICO scores declined in recent years as a result of the economic and housing downturn and where investors have played an important role in their recovery. As prices rise and rent growth flattens, investors will pull back and it is not clear that the PLS industry is currently ready to provide financing for the nascent volume of home buyers needed to fill the void. Some private mortgage insurers recently announced willingness to underwrite mortgages with FICOs between 620 and 680. It will be particularly interesting and instructive to see how lenders respond to this change. But requirements at jumbo lenders and PLS remain significantly higher with minimum FICO scores above 720, down payments of 20% or more, and cash reserves of nine months or more. Fannie Mae and Freddie Mac as well as the FHA have new programs to help borrowers in these distressed areas, but they are less potent if reduced limits disqualify borrowers.
Beyond the distressed areas, borrowers pushed into the non-conforming space or from FHA to convention-conforming market may not have the same access to credit due to higher FICO, down payment, and reserve requirements. Since mortgage rates are already at parity or better in the jumbo space and part of the conforming-conventional, if a borrower had sufficient credit quality, the down payment, and the reserve requirements they likely would have already migrated to the private sector. Similarly, the FHA has been underpriced by the private MIs at the middle and upper price echelons since the fall of 2012. Lowering the limits could create a binding equity or credit constraint for the remaining borrowers in this space.
Finally, it isn’t clear that lowering the limits will stimulate the PLS market. There are still a number of issues hindering the PLS market including representation and warrants risk, the unfinished QRM rule, concerns about the implementation and ramifications of the qualified mortgage (QM) rule, secondary market reform and lingering negative investor sentiment. Nor is it clear that bank portfolios will expand to sustain these borrowers. The FHFA might accomplish its goal of expanding the private sector’s market share, but this feat would be accomplished by reducing the total number of borrowers, not by pushing borrowers into the private space.
Though well intended, a reduction in loan limits could crowd out many otherwise qualified and sustainable borrowers. There may be a time when the PLS sector is ready, but it isn’t clear that PLS issuers are ready to take up the baton of borrowers impacted by lowering the limits.
 Based on analysis of 2012 HMDA dataset