Should Conforming Loan Limits Be Increased?

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On October 1st, 2011, the conforming loan limit for loans backed by the FHA, Fannie Mae, and Freddie Mac fell back down to the levels they were at before 2008. Less than a month later, the Senate has passed an extension of the law that raised those limits. Now the bill is going to the House for approval. Here is how it may affect you. (See also: Guide to Home Loans)

First of all, let me explain what a conforming loan is. Basically, a loan is "conforming" if it is smaller than the limit that the FHA, Fannie Mae, or Freddie Mac set. Conforming loans can be purchased by these agencies, so these loans are more liquid, and borrowers with conforming loans qualify for the best mortgage rates. If a loan is larger than that limit, then it would be a "jumbo loan," and the interest rate is generally a percent or more higher than a conforming loan. Right now over 90% of new home loans are backed by FHA, Fannie Mae, or Freddie Mac, so new house purchasers should know that if their loans are larger than the conforming loan amount, they would be more expensive and less likely to be funded.

Fannie Mae and Freddie Mac currently have a conforming loan limit of $417,000 in most areas, and a maximum of $625,500 in high-cost areas for a single-unit residence. FHA loans currently have a conforming loan limit of 95% of the median home price in an area or $625,500, whichever is less. In 2008, the Housing and Economic Recovery Act raised these limits significantly. The maximum loan amount for all the agencies was as high as $729,000, and the FHA loan limit was raised from 95% of the median home price to 125% of the median home price. Basically, now the lawmakers want the loan limits to be back to the limits under the 2008 law.

This loan limit issue affects FHA borrowers the most, since the difference in the loan limit in many areas changed more than 30%. FHA buyers typically only bring 3.5% of the home cost to their down payment, so basically the loan limit is the maximum price of the house they are purchasing. The good news for today's buyers is that housing prices have already come down more than 30% since 2008 in many areas, so the change in limit might not be a big deal because many houses are just plain more affordable.

The loan limit issue also affects upper-middle-class buyers in high-cost areas. Here in the San Francisco Bay area, there are many upper-middle-class families who look for very basic two-to-three bedroom houses that cost more than $800,000. For these families, they may have to lower their price points by $100,000 or pay thousands of dollars more every year.

Personally, I believe that the government should not encourage more debt by raising the limit. If you look at a history of the conforming loan limit, then you will see that it was raised drastically during the housing bubble. If large government-backed mortgages were not so easy to come by, then people might have bought cheaper homes, and perhaps we would not be in the situation we are in right now. I actually think that these loan limits should be decreased so that the private markets will have to shoulder more loans and more than 90% of the mortgage market is not backed by American taxpayers.

What do you think? Do you want the loan limits to go back to the 2008 limits?