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June 28th, 2011 (Modified on July 1st, 2011)

Lower loan limits will hurt home values

by Peter Miller


5-price-reducedThe National Association of Home Builders is out with a new study which tells us that real estate demand will fall and home prices will be pushed downward when new and lower loan limits begin October 1, 2011.

What lower limits?

In general terms, the high-water mark for conventional loans will slide from $729,750 to $625,500. The lower limits will impact 204 counties, or 6.5 percent of the 3,143 counties in the U.S. However, the NAHB said “these counties also represent relatively dense concentrations of population and housing. In fact, the affected counties contain 20.7 million owner-occupied housing units of the 75.3 million nationwide or 27% of all owner-occupied housing in the U.S.”

Also, the NAHB said that on average, the typical loan limit will fall by $67,018, or 11 percent.

It’s easy to understand why an association of home builders would be so concerned by the loan limit decline. It’s going to be tough to sell mini-mansions when the financing is more expensive.

Will financing be more expensive?

Borrowers who want jumbo financing, home loans above the loan limit, will have no challenge finding either lenders or loan options. Traditionally, there has been a premium for jumbo financing, say the rate for a conforming loan product plus, 0.6 percent, for example. In other words, if a conventional loan is available at 4.5 percent interest, a jumbo can most likely be had for 5.1 percent.

Avoid a jumbo and its extra cost

When the loan limit is lowered, loans above $625,500 but below $729,750 will suddenly become jumbos–and thus more expensive.

The higher cost of jumbo financing is something to avoid if only to escape higher mortgage costs. A now-conventional $650,000 loan at a time when mortgage rates are averaging 4.5 percent over 30 years will cost you $3,293.45 per month for principal and interest. Re-label the loan, call it a jumbo mortgage, charge 5.1 percent, and the new monthly cost will be $3,529.17.

In our example, monthly costs have increased by $235.72, or $2,829 per year.

Demand could decrease

People prefer lower prices. Thus, more expensive mortgages are not going to increase buyer demand. That’s a problem in several ways:

  1. People will look for homes which can be financed with a conventional loan to avoid the jumbo premium.
  2. A lot of big-city real estate requires financing above $625,500 to purchase (if we assume that prices do not fall any further). In many markets, that’s a dicey assumption.
  3. According to the NAHB:

Affected homes, if they were to be placed onto the for-sale market, would likely require financing with higher mortgage interest rates and other less favorable loan terms, such as higher required downpayments and more stringent credit history thresholds. This would reduce housing demand and place downward pressure on prices. As home sales are inter-related (for example, starter homes are sold to first-time homebuyers by move-up buyers), this pressure on prices could spill over on other homes in the affected areas.

Smaller loan amounts=lower home prices

The question is, how to solve the problem of lower home prices which will likely arise from smaller conventional mortgages.

The quick solution would be to keep the higher loan limits that we have today. And, politically, that remains possible.

But the real problem is different. No amount of loan-limit gamesmanship can change the fact that it takes income to pay off a mortgage, and income–when corrected for inflation–has actually declined. On average, a household that earned $52,587 in 1999 was earning $50,303 in 2008, according to the Census Bureau.

Many homes which were bought between 2005 and 2008 were over-priced because the marketplace was flooded with loans and easy terms. Buyers could bid up prices because they had “non-traditional” financing that allowed them to pay more for housing even though their income had not kept up.

We’ll miss the good old days

We now have a situation where many owners have huge mortgage debts, debts greater than the value of the real estate which secures the loans. If we keep loan limits high then perhaps some owners will be able to sell with smaller losses or even no loss. If we reduce the loan limit then it will be more difficult for such homeowners to unload over-priced property.

In the end, the new loan limits are likely to begin in October. As much as we might pine for the good old days, they’re gone, along with the economics they fostered.

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Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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