New Conforming Loan Limits

The Economic Stimulus Act of 2008 contained some good news for homeowners in high cost areas. The legislation authorized the Department of Housing and Urban Development to raise the loan limits for mortgages that can be purchased and guaranteed by Fannie Mae and Freddie Mac. The new maximum limit for such loans is $729,750, a 75% increase over the old maximum limit of $417,000. The new law also boosted the limits on loans insured by the Federal Housing Administration (FHA), but it’s very unlikely any of our clients will qualify for an FHA loan.

The primary expected benefit of the new limits is lower interest rates on mortgages used for purchasing a new home or refinancing an existing mortgage. In high cost areas like the California coast, homeowners routinely borrow amounts, so-called jumbo loans, much greater than the prior $417,000 limit. The higher $729,750 limit should permit more borrowers to finance real estate transactions for their primary residence or second home with conforming loans that are cheaper. Loans backed by Fannie and Freddie normally carry interest rates that are between .25% to 1% lower than the rates on loans that are not guaranteed.

However, there are a number of factors at play that may result in a relatively modest benefit to many borrowers when all is said and done. First, the new limits only apply for loans originated by the end of 2008. Moreover, many lenders will initially likely apply the new limits only to 30 year or 15 year, fixed rate, fully amortizing loans. Conforming adjustable and interest-only loans (our general preference for our wealthy clients) should come on-line later. Finally, because of the current credit market turmoil, and for other reasons, our banking contacts tell us the interest rate offered by many lenders on so-called conforming jumbo loans—amounts between $417,000 and the new $729,750 maximum—may not come down by as much as under traditional arrangements. Consequently, we may see two or more tiers of “conforming” loans with a higher interest rate for conforming jumbo loans. That said, we are seeing some big spreads between conforming and non-conforming 30 year, fixed rate, fully amortizing loans, but the absolute cost of those loans ,with their amortization feature, still make them less attractive for many clients.

Lenders are just beginning to roll out programs and pricing for loans to conform to the new limits. The first reports we have received are that pricing is not yet very beneficial, with interest rates higher than expected. But most of the mortgage brokers we talk with expect pricing to improve over the coming months. And the recent action allowing Fannie and Freddie to reduce the amount of capital they must hold as a cushion against losses, while arguably not prudent banking, should free-up capital to purchase and guarantee more mortgages, which may help lower conforming loan interest rates. By the time you read this, we may know more.

Meanwhile, a few general observations probably still apply:

• Clients with an appetite for indirectly levering an investment portfolio should continue to seek the maximum tax-deductible mortgage amount they can obtain, which is a $1.1 million, non-conforming loan. Why? Because unless spreads between conforming and non-conforming jumbo loans become durably much larger than we anticipate, we still think that investment returns produced by indirectly levering the larger mortgage will more than compensate for the slightly higher after-tax cost of the debt. (See box below)

• In contrast, for clients with less appetite for leverage and who sleep better with a smaller mortgage who are purchasing a home or refinancing in 2008, could find the new conforming jumbo loans more appealing.

• In certain circumstance, clients who are no longer actively employed may find it easier…especially in the credit environment of 2008…to get underwritten for a conforming jumbo loan instead of a non-conforming jumbo loan.

• Conforming jumbo loans will have a very limited appeal to clients if, despite expectations to the contrary, lenders only apply the new limit to 30 year or 15 year fixed rate, fully amortized loans.

As noted earlier, there is still much to be learned about how the new limits will impact mortgage options. We plan to write on this topic again after the banks and other mortgage lenders fully roll out their programs. In the meantime, you should call your Kochis Fitz/Quintile client service team with any questions about how these developments may impact your personal financial situation.

Tom Tracy