Regulators Weigh Reductions in Size of U.S.-Guaranteed Mortgages

Lawmakers and regulators are debating whether it’s time to shrink the size of mortgages that the U.S government will guarantee, five years after they first boosted loan limits in response to the financial crisis.

President Barack Obama and housing regulators have been calling for gradual reductions, citing a need to contract the government’s 90 percent share of the mortgage market. Trade groups including the National Association of Realtors say it’s too risky to make a change that would increase borrowing costs for some homebuyers at a time when interest rates have been rising and the effect of new lending regulations is still unclear.

Because of concerns that lenders will be too busy dealing with new mortgage rules to handle a simultaneous change in loan limits, the Federal Housing Finance Agency will wait until after the beginning of 2014 to reduce the maximum size of loans that Fannie Mae and Freddie Mac will buy, acting director Edward J. DeMarco said today.

The regulator of the two government-sponsored enterprises said during a briefing with reporters that he still intends to shrink the limits at some point and will give at least six months’ notice beforehand.

“Gradual reductions in the maximum loan size is consistent with the strategic goal we’ve set forth in the last year about gradually contracting the enterprises’ footprint,” DeMarco said.

Tracking Prices

Until the financial crisis, limits on government-guaranteed loans tracked home prices, typically rising at the beginning of each year as real estate became more expensive. That practice stopped when prices collapsed.

The Housing and Economic Recovery Act, or HERA, adopted in 2008 to stem the damage from the credit crisis, temporarily boosted maximum loan limits in high-cost areas such as New York and Los Angeles and kept the limits in most other areas the same even as prices plummeted. That’s remained unchanged as the market recovered, even with prices that are still 21 percent below their 2006 peak, according to the Case-Shiller 20-city home price index.

Current loan limits “are high relative to historical standards,” said Robert Van Order, a finance professor at George Washington University and former chief economist at Freddie Mac. “Ultimately, I think there’s a case for having them go down.”

Still, Van Order said, “it would be a mistake to drop loan limits precipitously” because the market is still fragile.

Two Limits

Fannie Mae and Freddie Mac currently buy loans as large as $625,500 in high-cost areas and as large as $417,000 in other markets. After purchase, the government-owned companies package the mortgages into securities, collecting fees to guarantee payments of principal and interest.

Mortgages eligible to be bought by Fannie Mae and Freddie Mac, known as conforming loans, are generally less expensive than larger loans known as jumbos because the government would absorb the cost of default. Lowering the limits would shrink the pool of borrowers able to obtain cheaper financing because of the government guarantee.

The current debate began in August after Obama released a housing plan urging regulators of Fannie Mae, Freddie Mac and the Federal Housing Administration to “closely examine using their existing authorities to reduce loan limits further.” DeMarco issued a statement saying FHFA was considering reductions.

Since then, housing industry groups have been trying to make the case that the market’s not ready.

Private Lending

“While there’s been some return of private lending without the benefit of a federal guarantee, it remains limited and available to the most highly qualified borrowers,” the Realtors’ association wrote in a September letter to DeMarco and members of Congress.

Loan limits shouldn’t be decreased until the mortgage industry has time to assess the impact of the qualified mortgage rule, a regulation that will go into effect in January setting standards for loans deemed non-abusive, said Mortgage Bankers Association Chief Executive Officer David Stevens.

Government-backed mortgages, known as agency loans, are temporarily exempt from the new rule, so decreasing loan limits would shrink the pool of loans that would be protected from any market disruptions it causes, he said.

“If there’s a credit availability concern and we’re not sure what kind of non-agency lending is going to be done, we should hesitate,” he said in an interview.

More Time

FHFA agrees that the industry needs more time, DeMarco said today. “The industry has an awful lot going on on Jan. 1,” he said. “The better course was to wait and provide a sense that there would be an ample amount of time for market participants to adjust.”

FHFA could have more to say about potential decreases when it issues its annual statement on loan limits in November and will give at least six months’ notice before taking any action, he said. Any eventual reduction would apply to both the base limit and the higher limit in expensive markets.

FHA’s limits have been higher than Fannie Mae’s and Freddie Mac’s for the past two years, pushing some larger loans to the government mortgage insurer. Housing industry groups don’t oppose a drop to $625,500 from $729,750 scheduled for January in the maximum size of loans that the FHA will insure in high-cost markets.

Meanwhile, there’s evidence that private capital could absorb some of the business if Fannie Mae’s and Freddie Mac’s limits fall. Production of mortgages above conforming limits accounted for 18.1 percent of new originations in the second quarter, the highest market share since 2008, according to data from Inside Mortgage Finance.

Mortgages’ Impact

The impact of a decrease would be largely confined to states with high housing costs such as California and New York, while states such as Texas would be relatively unaffected because most loans are under the limits, IMF found.

“It’s so hard to say what the housing market can or cannot handle in terms of changes,” Guy Cecala, publisher of IMF, said in an interview. “Two years ago, we had mortgage rates at near-record lows, and the housing market was dead. If anything, that told us that housing activity is not dictated by mortgage interest rates alone.”