In early September, the Federal Housing Finance Agency (FHFA), the entity that oversees Freddie Mac and Fannie Mae, gave notice that it would revise the conforming loan limits in an attempt to stimulate the private sector, specifically the private mortgage securitization (PLS) market. Though the reduction in the loan limits is expected to be modest, it could have more far reaching impacts at the local level and for affected borrowers.

Each year, the FHFA adjusts the national conforming loan limit, which defines the space within which Fannie Mae and Freddie Mac can finance mortgages. The national limit is $417,000, but that varies by county and can increase to $625,500 in high-cost markets. The FHA’s limits, which range from $261,050 to $725,750, are based off of the conforming limit, so the FHFA’s actions would impact FHA borrowers as well.

NAR research estimates that if the national conforming limit were lowered to $400,000, roughly 170,000 total mortgages and 60,000 purchase mortgages would have been impacted in 2012 (based on data from the FFEIC’s HMDA dataset). The total number was inflated due to the refinance boom in 2012. However, stronger price growth in 2013 has likely pushed more homebuyers toward the conforming limit. Most estimates have the impacted volume at roughly 3-5 percent nationally.

While the national figure may appear relatively small, the change could have a significant impact at the local level. The impact goes beyond the high priced markets on the coasts and would affect some smaller communities in the Midwest and South. Furthermore, several of the markets in the top 25 most impacted are in formerly distressed areas (e.g. Atlanta, Sacramento, Riverside-San Bernardino, Oakland and Phoenix). These are areas where FICO scores declined in recent years as a result of the economic and housing downturn and where investors have played an important role in their recovery. As prices rise, investors will pull back and it’s not clear that the PLS industry is currently ready to provide financing for the nascent homebuyers needed to fill the void. Some private mortgage insurers recently announced willingness to underwrite mortgages with FICOs between 620 and 680. It will be particularly interesting and instructive to see how lenders respond to this change. Fannie Mae and Freddie Mac—as well as the FHA—have new programs to help in these distressed areas, but they are less potent if reduced limits disqualify borrowers.  

Beyond the distressed areas, borrowers pushed into the non-conforming, or from FHA to conventional-conforming market, may not have the same access to credit due to higher FICO and down payment requirements. Since rates are already at parity or better in the jumbo space and part of the conforming-conventional, if a borrower had sufficient credit quality or the down payment, they likely would have already migrated to the private sector. Similarly, the FHA has been underpriced by the private MIs at the middle and upper price echelons since the fall of 2012. Lowering the limits could create a binding equity or credit constraint for the remaining borrowers in this space. 

Finally, it isn’t clear that lowering the limits will stimulate the PLS market. There are still a number of issues hindering the PLS market, including representation and warrants risk, the unfinished QRM rule, concerns about the QM rule, secondary market reform and lingering negative investor sentiment. Nor is it clear that bank portfolios will expand to sustain these borrowers.

Though well intended, a reduction in loan limits could crowd out many otherwise qualified borrowers. There may be a time when the PLS sector is ready, but it isn’t clear that PLS issuers are ready to take up those borrowers impacted by lowering the limits.

Ken Fears is the Director of Regional Economics & Housing Finance for the National Association of REALTORS®.