FHA Loan Limits May Drop on October 1

One of the many pieces of emergency legislation passed during the financial crises was a bill that increased conforming loan limits for FHA borrowers.  The Federal Housing Administration guarantees loans at competitive market rates, but only requires borrowers to put down at least 3.5%.  Also, the debt-to-income ratios can be higher and there are no income qualifications, which allows borrowers to qualify which may not qualify for conventional loans.

However, unless Congress extends the bill, it will expire on September 30.  Therefore, starting October 1, borrowers in this class may have difficulty borrowing to purchase a home.  They will have to have larger down payments, meet more stringent income qualifications, and possibly be subject to higher interest rates.

Lower Loan Limits

The conforming loan limit determines the maximum mortgage that the Government-Sponsored Entities (GSEs): FHA, Fannie Mae, and Freddie Mac, can buy or guarantee.  Loans that are guaranteed by the GSEs make up over 90% of the mortgage market, and as a result, can be easily found by buyers.  Not having a GSE loan usually requires much higher down payments and interest rates, as these loans usually stay in private hands.

The conforming loan limit was adjusted by county due to the legislation that was passed.  As a result, each county may have a different limit.  In California, there are several counties that will see a drop of over $100,000 in the conforming loan limit.

You can see how your county will be affected by these changes at the FHA Website. 

Jumbo Loans and Interest Rates

Since the conforming loan limit is dropping, this means more people may opt for non-conforming jumbo loans.  These loans typically charge higher interest rates and require a larger down payment – at least 20%.  The typical rate difference between a conforming and non-conforming loan is usually between 0.875% and 1.5%.

Tighter Borrower Requirements

Current FHA requirements allow for lower credit scores, lower incomes, and lower down payments than traditional conforming loans.  Furthermore, an FHA loan can usually be obtained within 3 years of foreclosure or bankruptcy, compared to the 7+ years for a traditional loan.  These benefits will still apply after the loan limits drop, but borrowers will simply not be able to exceed the new lower limits.

Impact on the Housing Market

I don’t think this will greatly impact the housing market, as most individuals who are purchasing a home using an FHA or GSE backed loan do not buy over the conforming loan limit.  Where I do see the possibility of softness is in the segment of individuals who strategically short-sold their home to get out of it.  They may have been poised to purchase a larger home, and now may have trouble financing it due to the potential new restrictions.

Readers, what are your thoughts on the potential FHA loan limit changes?  Is it a good thing or a bad thing?