As rates increased, average monthly payments also rose. The consequence was that home sales fell as fewer people could afford to buy. Additionally, beginning in mid-2007, many homeowners who had taken out adjustable rate mortgages (ARMs) to finance their purchases made after mid-2005 could not refinance. Stagnant or declining prices reduced or eliminated the equity in their home. Unable to refinance, households were faced with making monthly mortgage payments that they could no longer afford. The impact of this trend was particularly harsh on the sub-prime market as funding in this sector evaporated after July of 2007. Default and foreclosure rates increased as a result.
Some Relief in Sight
The good news is that there is some relief on the way. One month ago, Congress passed and the President signed an important stimulus package that goes far beyond the well-publicized $600 tax rebate check. The package includes a provision that will temporarily increase FHA lending limits and the limits on loans that the GSEs can buy.
Prior to 2008, the FHA could only loan up to a maximum of $362,790 for a home in the highest priced markets; most markets had lower limits. Under the new provisions, that limits jumps to as much as $729,500 depending on the local median home price. Based on 2007 mortgage data, NAR Research estimates that more than 140,000 homes in this price category were purchased using sub-prime loans.
FHA vs. Subprime
FHA loans compete with sub-prime loans for borrowers with lower credit standards. However, the FHA has a longer history of lending and has government support, so borrowers receive mortgages rates that are 3.0 percent lower on average than those of subprime loan. In addition, these FHA loans require inspections; users of the FHA program know about issues with their home up front and so can budget accordingly. In short, FHA loans cost home buyers less up front and allow them to budget their long-term expenses more accurately. Finally, FHA has programs in place to keep owners out of foreclosure if they become delinquent – a lesson the private, subprime sector is currently learning.
FHA and Housing Demand
Because FHA loans are considered safe, the increased FHA limits will help stimulate housing demand from buyers with less-than-perfect credit. That in turn will help to support prices, enabling owners facing re-setting of their mortgage-interest rates to refinance into more affordable loans. This will further undercut the precarious position of housing markets with large concentrations of sub-prime ARM loans.
Increased GSE Loan Limits
Equally important are the effects that increased GSE limits will bring. The GSEs, Fannie Mae and Freddie Mac among others, buy up loans, repackage them, and sell them in the secondary market. The GSEs’ loose relationship with the government is viewed by buyers of mortgage backed securities as insurance – that the risk on these mortgages is much lower than that on mortgages not backed by the Federal government or the GSEs.
The subprime meltdown last summer caused the spread between conforming mortgages rates, those at or below $417,000 that by law could be backed by the GSEs, and jumbo rates to surge nearly a full percentage point. This increase knocked many would-be buyers out of affordability. The difference between 6% and 7 percent is magnified on a monthly payment as the home’s value increases. Now that the GSEs can buy loans above $417,000 up to $729,750, mortgage rates on non-GSE backed loans in this range will likely come down as well. This change will help to boost demand in the volatile, high-priced markets on the east and west coasts.
Impact on Markets
Nearly every county in the county will benefit from this change. Of the 3,190 counties in the United States, 100 will see an increase of 100 percent or more in their FHA loan limit. An additional 3,070 counties will receive an increase of 30 percent or more in their FHA loan limits. Many of the high-priced markets on the east and west coast will experience sharp increases in FHA limits. On average, counties in California will experience an increase of $185,361, with many counties in Los Angeles, San Diego, and San Francisco receiving more. Lower priced areas in the central valley that are experiencing sharp foreclosures – including Modesto, Sacramento, and Stockton – will also experience significant boosts. Washington, D.C., New York City, Boston, and Chicago are just a few of metro areas that will experience sharp increases in both FHA and GSE limits.
However, it’s not just large metros and suburban areas that will benefit. There are many smaller markets that will feel the positive effects of increased loan limits. Some smaller, coastal counties in New Jersey, North Carolina, and Virginia as well as Nantucket have received substantial increases in their loan limits. Other areas have received sizable increases such as popular counties in Colorado outside of Denver and Boulder as well as Lancaster, Ohio and recent boom markets like Wasatch, Utah.
Finally...The new FHA loan limits combined with the new GSE loan limits will go far to re-vitalize demand in today’s sagging housing market. More importantly, these changes will help to strengthen confidence, the fabric of the industry’s damaged mortgage market, and it will do so at the local level.
by Ken Fears, Manager, Regional Economics
