On October 1st, new, lower conforming loan limits will go into effect. Two hundred fifty counties will be impacted by this change (see the map below), and this brief analyzes two main questions about this change:
What are these loans?
A conforming loan is a mortgage loan that conforms to the government-sponsored enterprises’ guidelines (Fannie Mae and Freddie Mac). These guidelines set a limit on the amount of the loan that varies by region in the United States. In many regions this limit is $417,000 for a single-family home, however in higher-priced regions this limit is higher due to higher living costs. These higher limits are referred to expanded conforming loan limits and loans that fall between $417,000 and this higher limit for the pricey regions of the U.S. are called expanded conforming loans. If a potential home buyer is interested in purchasing and financing a home that is more expensive than $417,000 (or the expanded limit in the pricey regions of the U.S.) he or she has to choose a so-called jumbo mortgage. Currently, the expanded conforming loan limits are set at 125 percent of the 2007 median home prices in a region up to a maximum of 175 percent of the baseline national limit, or $729,750 ($417,000 times 175 percent) as established under the Economic Stimulus Act of 2008. Under the new formula, which was established by the Housing and Economic Recovery Act of 2008, expanded conforming loans limits are set at 115 percent of contemporary median prices, up to 150 percent of the baseline national limit, or $625,500.
Why should consumers care?
These different types of loans, conforming, expanded conforming and jumbo all have different levels of rates attached to them because they range in riskiness from lowest to highest. A jumbo loan is considered riskier by lenders because the secondary market for jumbo mortgages is relatively illiquid. Fannie Mae and Freddie Mac only buy loans that follow their guidelines and therefore fall under the category of conforming loans. They will repackage these loans for the secondary market in form of mortgage-backed securities (MBS). An MBS allows investors to purchase a share of the return from the pool of mortgages inside the security, thus lowering the risk to any single investor of default by an individual loan within the overall pool of mortgages. Because this type of securitization is less prevalent for non-conforming loans (because Fannie and Freddie aren’t buying them), it is harder for lenders to sell these types of loans making them, in turn, riskier to hold. Due to this illiquidity, jumbo loans will have a higher interest rate than conforming loans and expanded conforming loans.
Currently, the expanded-jumbo spread is in the range of 30 to 40 basis points. As figure 2 below shows and as we have discussed before the spread between conforming and jumbo loans has recently become narrower, as has the spread between expanded conforming loans and jumbo loans.
How many consumers are affected?
To examine the impact of the changing loan limits we consider the two questions outlined briefly in the beginning of this brief. The first question relates to the number of mortgage applications that would be affected by these changing loan limits. To proxy for overall national mortgage market, we use data from the Zillow Mortgage Marketplace (ZMM) over the last year. ZMM is relatively representative of the marketplace as a whole as analyzed in this earlier brief. In the first seven months of 2011, consumers submitted more than 2.6 million ZMM loan requests. In addition, the ZMM mortgage rate very closely tracks the Freddie Mac weekly mortgage rate survey.
Using the ZMM data, we are able to examine the number of mortgage applications submitted over the past one year that are above the new limits that will become effective on October 1st but below the current limits in effect now. These mortgage applicants will have to pay a higher mortgage rate after October 1st or make a higher down payment in order to reduce the mortgage balance below the new limits.
The analysis reveals that, while only 250 counties are affected by the changing conforming loan limits, some counties are harder hit than others. The map and table below show that, of the 250 counties, counties in California, Virginia and Washington are hardest hit. For example, in San Juan County in Washington State 20 percent of the submitted loan requests would no longer be able to apply for an expanded conforming loan, but must now consider a jumbo loan. Roughly 17 percent of the loan requests in Monterey County in California are affected and closely following that county are San Mateo and San Francisco at 14 percent affected. This metric gives a sense of how current mortgage demand will be affected.
The second question outlined in the opening of this brief relates to the number of homes in each county that could be affected by the change if new mortgages were originated on the homes. In other words, the number of homes in these 250 counties, which could be financed with an expanded conforming loan currently, but cannot be financed so after October 1st, 2011. This number is estimated based on each home’s Zestimate, assuming 20% down payment for a typical mortgage, and it overall yields a very similar result to the first metric (see the dark grey vs. the light grey bars in the bar chart below). Some differences can be seen, for example, in Summit County in Utah and Dukes County in Massachusetts. In Summit County, only 1.3 percent of the mortgage requests are affected by the changing conforming loan limits, however almost 10 percent of the houses in this county, if sold, would now have to be financed by a jumbo loan.
Overall, only 2.5 percent of the houses in the 250 counties are affected by this new limit change, which represent 0.75 percent of all houses in the United States. In terms of the number of mortgage application affected, we find that 3.9 percent of the mortgage applications in the 250 counties are affected, representing 1.7 percent of the total number of applications in the US. While the impact of the changing loan limits is relatively small in aggregate, there are some larger local impacts where individual counties could be harder hit. It’s undoubtedly a delicate balance that must be struck here. On the one hand, we do continue to have a fragile housing market that we should be cautious about upsetting. On the other hand, our mortgage market has become one that is currently almost entirely dependent on government support and that situation is problematic in the long term. Arguably, this small step at reducing the support of the mortgage market by the government is a reasonable first step.