Discussions continue to be ongoing around the subprime mortgage crisis and how best to help the consumer get out (and hopefully stay out) of mortgage trouble. While many solutions have been bantered about including rate freezes, foreclosures freezes, and government sponsored refinancing, another important piece of legislation is also being discussed. Congress has begun discussing the potential to increase the maximum loan amount of conforming and FHA loans.
Conforming and FHA Loans
Conforming loans represent the bulk of mortgage loans most people have on their houses. These loans are called conforming because they conform to standards set by Fannie Mae and Freddie Mac. These organizations buy mortgages from banks and other mortgage originators. To make a very complicated process short, consumers received significantly lower rates because of this process. Additionally, these loans are guaranteed by Fannie and Freddie, who turn around and sell them to investors. Currently, the maximum conforming loan amount is capped at $417,000.
This change represents a government acknowledgement that real estate prices have increase dramatically over the past decade. While the median home price in the United States is currently well under the cap of $417,000, in many areas of the country real estate values are significantly higher than the cap. In areas like New York City, the West Coast, and some areas of Florida, buyers need to spend at least $500,000 to be on the lowest end of the market. In Midtown Manhattan a 600 square foot studio sells for about $650,000. While those prices will seem outrageous to most people, they are a very real reality for millions of would be homeowners.
Increasing the cap serves these markets better than the current situation. Conforming loans make housing more affordable. In many situations these homeowners have to take out two mortgages, a first conforming mortgage for $417,000 and an additional home equity mortgage for the balance of their loan. The rates on the second mortgage range from 3-4% higher than conforming rates. This new legislation could save homeowners $500 or more per month, with very little cost to anyone.
The major drawback to this move is the potential for additional inflation in the real estate markets. In markets where many could argue real estate is already overpriced, allowing for cheaper loans could lead to an even bigger future crash in the real estate market. Additionally, if foreclosures rise in these markets, the government, who implicitly guarantees these mortgages through Fannie and Freddie, might be on the hook for a much bigger tab. This means, inevitably, the tax payers will bear this burden.