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The coming FHA loan limit battle

by Peter G. Miller
October 6th, 2011

The battle of October 1st is over and financial sanity won out. The FHA has new and lower loan limits and now we need to get ready for Round 2.

The fact is that the loan limits that took effect at the beginning of this month might end on December 31st. That’s because the new loan limit formula is only designed to last three months.

In the usual situation loan limits are announced in November or December, begin in January and then last for a full year. However, since 2008 the loan limit system has been in a shambles and it still is today. The result is that as of January we could see higher limits, lower limits or no change.

Changing FHA limits

Lenders, brokers and homebuilders want larger FHA mortgages for a few reasons: The financing only requires 3.5 percent down and there is no risk to anyone by those who pay FHA mortgage insurance premiums–if an FHA mortgage fails the lender has 100 percent loss protection.

Go back to 2008. The loan limits in place had been set in 2007. In April 2007 home prices reached their peak and then began to decline. Under the usual formula loan limits were scheduled to decline in 2008. Instead, under the stimulus package loan limits were increased. For FHA borrowers within the continental 48 states that meant the largest FHA loan for a single-family home could now be $729,750 instead of $417,000.

The process was repeated in 2009 and 2010. Now, in 2011, we’re trying to figure out what the loan limits should be in 2012 and so we’ve taken a half-step, lowering the limits as of October 1st through the end of the year.

But what will happen in January?

No doubt between now and January we’ll see huge complaints from lenders, brokers and builders, explained in horrid detail, about how the lower loan limits have adversely affected millions of people.

This is nonsense. Fewer than 1 percent of all FHA loans have initial balances of more than $500,000–and remember we’re allowing loans for as much as $625,500 under the new rules in high-cost areas, more in Alaska, Hawaii, Guam and the Virgin Islands.

Politics

Less visible will be the conversion of the loan limit issue into a political matter, meaning lots of PAC contributions for candidates running in 2012.

In the real world, loan limits for 2012 should actually be even lower than today because

home prices continue to fall. The Federal Housing Finance Agency says that home prices as of July remained 18.4 percent below the April 2007 peak.

In practice, the most likely outcome is that the loan limits we have today will simply continue into 2012. That will help FHA mortgage borrowers who need bigger loans while not actually having much marketplace impact. Why? There just aren’t a lot of massive loans among the 7.1 million FHA mortgages now outstanding.

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