If you’ve been home shopping this winter or work in real estate, you’ve probably heard more buzz again this year about the recent adjustment to conforming loan limits. With this year’s larger-than-normal increase, U.S. Bank financial industry and regulatory affairs expert Robert Schell shares his insights on why this occurred. Read on to learn what conforming loan limits are and how they impact the housing market.
Conforming loan limits, at their core, are used to separate conventional loans from jumbo loans. Fannie Mae and Freddie Mac, sometimes referred to as government sponsored enterprises (GSEs), set requirements like down payments, minimum credit scores, and documentation for mortgages they purchase. Additionally, the Federal Housing Finance Agency (FHFA), which regulates the GSEs, sets guidelines on maximum loan sizes (i.e., conforming loan limits) that qualify for purchase by Fannie Mae and Freddie Mac, helping them manage their risk when purchasing conventional mortgages from lenders.
Jumbo loans are mortgages that exceed these conforming loan limits. Unlike conventional mortgages, jumbo loans cannot be purchased by Fannie Mae and Freddie Mac. Instead, they generally must be maintained by the lender for the entire life of the loan. This puts increased risk on lenders and drives up interest rates for homebuyers.
Conventional mortgages are designed to benefit the average homebuyer, ensuring that the housing market is affordable for most people. Fannie Mae and Freddie Mac help make this possible by purchasing conventional mortgages from lenders. When a buyer takes out a home loan, lenders can sell the mortgage to Fannie Mae and Freddie Mac, who bundle numerous mortgages together to create securities. These securities are later sold on the secondary market.
Robert explains the process: “The GSEs take individual mortgage loans, buy them from lenders, and then pool them – or package them together – into securities. There might be one security that has a thousand mortgages from all different parts of the country. Those thousand mortgages are sliced and diced into different tranches of risk that investors might want to buy.”
When Fannie Mae and Freddie Mac buy a mortgage from a lender, they assume the associated risk and spread it between investors. If a homeowner defaults on their mortgage, the impact for lenders is significantly minimized because they've already sold off the mortgage to Fannie Mae and Freddie Mac. In turn, lenders are more likely to reduce interest rates.
Investors purchasing mortgage-backed securities benefit from the pooling together and repackaging of mortgages while guaranteed against the risk of homeowner default by Fannie Mae and Freddie Mac. Meanwhile, the GSEs benefit from the scale and diversification that makes the impact of a single mortgage default like a drop in the bucket compared to the more than $6 trillion of combined mortgage portfolios between both companies.
“By pooling risk and selling securities to investors, GSEs help make mortgages more accessible and affordable for borrowers,” Robert explains. “And they pull in additional investment money into the mortgage market, which helps make that happen.”
Every November, the FHFA adjusts the conforming loan limits to reflect changes in the housing market. This helps ensure the average homebuyer can still get a conventional mortgage, even as housing costs rise. The FHFA recently announced that the baseline conforming loan limit for 2022 will increase 18% to $647,200, with the limits up to 50% higher in designated high-cost areas. That’s more than double the percentage increase of last year’s record-setting 7.4% rise.
“When the FHFA does this, they’re just following a formula, they’re not making any judgment calls,” says Robert. “They’re looking at what home price data is saying and how it’s increasing from last year to this year. 18% is consistent with what the data says.”
But what made housing prices rise so sharply in 2021? It comes down to supply and demand. The housing market has a limited supply of houses, and, at least anecdotally, geographic mobility sharply increased in the last two years, causing both more buying and selling around the country. Global supply chain issues delaying new home construction and record-low mortgage rates that increase affordability and competition for houses have only compounded that impact. “We’re seeing the same effects, it’s just the second year of them and they’re accelerated,” Robert says.
FHFA Acting Director Sandra L. Thompson released a statement addressing the issue on the same day the 2022 conforming loan limits were announced:
“…Compared to previous years, the 2022 Conforming Loan Limits represent a significant increase due to the historic house price appreciation over the last year. While 95% of U.S. counties will be subject to the new baseline limit of $647,200, approximately 100 counties will have conforming loan limits approaching $1 million. FHFA is actively evaluating the relationship between house price growth and conforming loan limits, particularly as they relate to creating affordable and sustainable homeownership opportunities across all communities.”
As another key player in the housing market, the Federal Housing Administration (FHA) is required by statute to follow the example of the FHFA when setting loan limits for low-income and first-time homebuyers. Not surprisingly, they announced similar adjustments to their maximum loan limits this November.
According to Robert, the increase in loan limits itself isn’t alarming, since the FHFA is essentially just following a formula based on home prices. “The loan limits themselves are just a natural consequence of what’s going on in the housing market,” he says. “But these are big numbers that are being put out, in terms of price appreciation. It can price people out of the market and that’s something we should pay attention to.”
Get more insights from a U.S. Bank mortgage loan officer on how COVID-19 changed the housing market.