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Proposed FHA changes not a done deal

by Peter G. Miller
February 14th, 2011

In a report to Congress, the Obama administration says the time has come to “wind down Fannie Mae and Freddie Mac and shrink the government’s current footprint in housing finance on a responsible timeline.” A big part of that footprint involves FHA home loans, which the government wants to make smaller and more expensive.

FHA Changes

In terms of the FHA, the plan suggests that the current loan limit should be reduced from $729,750 — the amount for a single-family residence in a “high cost” area — to $625,500. (This is also the current maximum loan amount for FHA-insured reverse mortgages.)

A second change would revise FHA guidelines and raise the annual insurance premium from .90 percent for most borrowers to 1.15 percent.

Under the new system FHA loans would be less attractive than today. Given today’s current mortgage rates, present loan limits and attendant insurance costs borrowers with an interest in an FHA mortgage may want to consider financing or refinancing now rather than later.

Politics

The FHA has the authority to increase the annual mortgage insurance premium to as much as 1.5 percent. This is in addition to the up-front mortgage insurance premium which is now at 1 percent. In effect, the higher premium is a done deal, if that’s what the Obama Administration wants.

The revised loan limits are a different story.

Until 2008 the country had a system which generally increased mortgage loan limits each year. The system was supposed to reduce loan limits when home values fell but such inconvenient results were ignored.

In 2008 the country took the first visible hit from the mortgage meltdown. The mortgage loan limit should have dropped sharply but this was politically unacceptable. The result was that the government stepped in created a three-part loan limit system — the 2008 loan limits, high limits for “high cost” areas and really higher limits for Alaska, Guam, Hawaii, and the Virgin Islands.

The result was that the maximum conforming loan size could be $271,050 in some areas and as much as $1,094,625 in others.

But why were loan limits set so high in “high cost” areas?

This was a matter of politicians protecting their turf. In so-called high cost areas there were huge numbers of homes with prices above $700,000. The inability to refinance these homes with big conventional loans would have meant that buyers could only finance such properties with jumbo financing. And jumbo loans are a little more expensive then conventional financing, but more expensive enough to not be affordable for some borrowers.

The result is that while higher FHA premiums are a done deal, lower loan limits are not. It is entirely possible that Congress — which includes lots of lawmakers from expensive neighborhoods — will block the lower loan limit proposal.

Alternatively, senators and representatives outside high cost may favor the lower loan limits because they’re not benefiting from then today.

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