If you’ve been home shopping this winter or work in real estate, you’ve probably heard buzz around 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 2021 limit increase is the largest we’ve seen since 2006, with a 7.4% rise for most areas of the country ($548,250 base and higher in high-cost areas). That percentage may be even larger for high-cost areas like Alaska and Hawaii.
“What we’ve seen is an especially hot housing market in 2020, which led to big price increases for homes,” says Robert. “That big increase in prices led to a big increase in conforming limits.”
But what made housing prices rise so sharply in 2020? 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 2020, causing both more buying and selling around the country. Additionally, this year’s record-low rates made mortgages more affordable, resulting in bidding wars and buyers stretching their budgets.
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 December.
While the sharp increase in loan limits may seem alarming, Robert believes it’s a good thing. These adjustments show that the FHFA is paying attention to rising home prices and making changes to assist buyers. “This isn’t the world changing in any crazy way – it’s just everything trekking along as it’s supposed to.”
Get more insights from a U.S. Bank mortgage loan officer on how COVID-19 changed the housing market.