Are new loan limits for Fannie and Freddie too high?

The maximum for mortgages backed by Fannie Mae and Freddie Mac will jump to almost $1 million in high-cost markets like Los Angeles and Orange counties.

By Jeff Lazerson | jlazerson@mortgagegrader.com | MortgageGrader.com | December 04, 2021

Let the good times roll.

You now can buy a $1,021,895 home in Los Angeles and Orange counties with as little as 5% down and still get a loan backed by Fannie Mae or Freddie Mac.

The Federal Housing Finance Agency announced Tuesday, Nov. 30, the 2022 loan limit for high-cost metro areas like L.A./O.C. will rise to $970,800, up from $822,375 in 2021. As Fannie’s and Freddie’s conservator and regulator, the agency sets the limits for loans qualifying for more favorable interest rates.

Can you say boom and bust?

The 2022 conforming loan limits cap out at $647,200 in the Inland Empire. Any L.A./O.C. conventional mortgage at $647,200 or less is also priced as conforming.

Rates for conforming loans average about a quarter-point less than so-called high-balance loans.

There is potentially no better, and no more dangerous, a tool in the home buyer’s toolbox than mortgage finance leverage.

On the positive side, if you put 5% down ($50,000) on a $1 million property, and the property value goes up by 10% in a year to $1.1 million, you just made a cool $100,000 in your sleep. That’s a fair assumption as home prices have been appreciating at a 15%-plus clip over the past few years.

Assuming you qualify and have a middle FICO score of 740, your total monthly payment would be about $5,447, including taxes and insurance.

What would it cost you to rent a million-dollar home? Perhaps $4,500? This is a compelling argument to buy, especially when you consider the additional freedom of homeownership and the potential tax write-offs.

But what happens if we are closer to the danger of a bust? Home prices have been rising for almost 10 years. Then, that 95% leverage works against you.

If the value of that same $1 million property were to fall 10%, you’d have negative equity, owning a $900,000 home with a $950,000 mortgage.

Back in 2000, Tom LaMalfa, President TSL Research & Consulting Co., was sounding the alarm bells to then-Fed Chair Alan Greenspan and plenty of others of an coming Fannie, Freddie crash.

“We are in a similar situation as 2008. Nobody is expecting a decline in home prices,” said LaMalfa. “There is no material change in underwriting with high loan-to-values, high debt ratios and minimal FICO scores.”

Jonathan Glowacki, principal and consulting actuary at global consulting firm Milliman Inc., asked how much of the housing supply-demand imbalance is driving 20% home appreciation?

“What happens when the market normalizes again? Risk lies in how home prices behave when supply and demand come back to normalization,” he said.

Glowacki noted that computer-generated automated appraisals, or AVM’s, lack the intuitive thinking of a human appraiser. Think about how poorly Zillow’s automated valuation models have performed.

About 15% of the mortgage market before the housing crash of 2008 was called Alt-A or subprime, LaMalfa observed. Today, non-qualified mortgage or exotic mortgages are about 3% of the market. His point is F & F had the lion’s share of the mortgage market before the 2008 crash, and it still does today.

Fannie and Freddie are still in government conservatorship. If Fan and Fred crumble again, the taxpayer backstop is already there.

But F & F’s capital reserves are less than 1% on $6.1 trillion worth of mortgages, LaMalfa said. These are similar to levels prior to the 2008 mortgage meltdown.

According to the U.S. Census Bureau, there are close to 104 million 1- to 4-unit residential properties in the country.

There are 55 million mortgages in the U.S. Of those, 75-80% are guaranteed by the U.S. government — either by F & F, the Federal Housing Administration, Veterans Affairs or the Department of Agriculture, according to Ed Pinto, senior fellow and director of the Housing Center at the American Enterprise Institute. Keep in mind VA and FHA mortgage limits will mimic those of Fan and Fred after Jan. 1.

When it comes to purchases, how much high leveraging is really happening, then and now? It’s eerily similar.

Average down payments for Fannie and Freddie mortgages are lower this year than in 2007, the year the meltdown started, CoreLogic figures show. For example, F & F down payments for a U.S. home averaged 15% this year so far, compared with 17% just before the housing crash.

Locally, average down payments ranged from 17-24% this year in Los Angeles, Orange, Riverside and San Bernardino counties, compared with 19-26% in 2007, CoreLogic figures show.

On the other hand, U.S. homeowners have a lot more home equity (and less debt), Black Knight figures show. The average homeowner had 55% equity as of September compared with 36% in 2007.

In Los Angeles and Orange counties, homeowners averaged 65% equity in September vs. 46% in 2007; in the Inland Empire, average equity is about 56% vs. 29% before the crash.

Any type of distressed sales experiences a 10-15% price discount, according to Glowacki.

The big challenge is highly leveraged borrowers or underwater borrowers will be stuck should they need to sell. When distressed sales happen, AVM’s and human appraisers cannot ignore them. There will be a domino effect.

Freddie Mac rate news: The 30-year fixed rate averaged 3.11%, up 1 basis point from last week. The 15-year fixed rate averaged 2.39%, 3 basis points lower than last week.

The Mortgage Bankers Association reported a 7.2% slide in mortgage application volume from the previous week.

Bottom line: Assuming a borrower gets the average 30-year fixed rate on a conforming $647,200 loan, last year’s payment was $139 less than this week’s payment of $2,767.

What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages without points: A 30-year FHA at 2.25%, a 15-year conventional at 2.375%, a 30-year conventional at 2.875%, a 15-year conventional high-balance ($647,201 to $970,800) at 2.625%, a 30-year conventional high-balance at 3.125% and a 30-year fixed jumbo at 2.875%.

Eye catcher loan of the week: A 30-year mortgage with an interest-only adjustable rate for the first 10 years at 2.875% without points.

Jeff Lazerson is a mortgage broker. He can be reached at 949-334-2424 or jlazerson@mortgagegrader.com. His website is www.mortgagegrader.com.

* Specific loan program availability and requirements may vary. Please get in touch with your mortgage advisor for more information.