Houston, we have a problem

In looking at markets that may see a temporary increase in the $417,000 conforming loan limit, I ran a table yesterday that relied on median home price data from the third quarter 2007.

Running the numbers again today with preliminary fourth quarter numbers from NAR highlights a potentially serious problem. All 19 metropolitan statistical areas (MSAs) identified as places that might see an increase in the conforming loan limit are declining markets. In just one quarter, four of these markets saw median sales prices decline more than 10 percent (click on "continue reading" to see table with updated numbers).

This creates at least two potential issues. One, the estimated new limits in yesterday's table probably overestimate what the new conforming loan limit might be in these markets -- in some cases, by quite a bit.

In the case of L.A.-Long Beach-Santa Ana, where prices fell 13.4 percent from quarter-to-quarter, the new loan limit would be almost $100,000 less than projected using the older numbers ($637,125, rather than the $729,750 cap).

Riverside would barely sees an increase, to $422,500. Sacramento now looks like it won't see an increase at all, based on the new fourth quarter numbers.

The earlier projections remained unchanged in just three markets -- Anaheim, San Francisco, and San Jose --  because prices are so high, they are still bumping up against the $729,500 cap despite price decines. Note that the estimated loan limit for Boulder, Colo., actually increased slightly from the table published yesterday even though prices fell during the fourth quarter, because NAR also revised its third quarter numbers for that market. 

The dramatic price declines in many of these markets raises another, potentially more troubling issue: will Fannie Mae and Freddie Mac have to require larger down payments, or raise their rates and fees considerably to offset the risk of purchasing or guaranteeing these "jumbo light" mortgages? It may be that if they don't, secondary market investors won't want to buy securities backed by these loans, because of the risk that borrowers will end up upside down.

Fannie and Freddie have already increased surcharges for borrowers with credit scores below 680 and are now requiring down payments of at least 5 percent on loans in declining markets (see Inman News story).

If raising the conforming loan limit doesn't do much to reduce borrowing costs in these markets, the benefits for housing markets may be less dramatic than some have hoped.

UPDATE: For an insider's perspective of the issues that will affect the interest rates on new "jumbo light" loans, see this internal memo from a SunTrust Mortgage executive to the company's sales force, posted on Blownmortgage.com.

SunTrust Mortgage executive Tuck Reed says: "How much, if any, improvement the lucky loan balance winners will receive is a function of two things: how much of the current spread between agency and non-agency pricing FNMA decides to keep for the home team and how well investors accept the new loan balances in agency MBS."

Assuming Fannie and Freddie charge "a reasonable premium over today’s fees to compensate for the higher credit risks and assuming reasonable liquidity for the new MBS, we estimate the 90 bp spread could drop to as low as 50 bps – significantly better than today."

Translation: instead of carrying an interest rate that's about 1 percent higher than a conforming loan, buyers who fall within the new loan limit could lock in interest rates only about 1/2 percent above those on loans that meet the existing $417,000 limit.

Reed expects that with a maximum 90 percent loan-to-value requirement (in other words, a minimum 10 percent down payment) and a prohibition on interest-only loans, the new loan limits will give Fannie and Freddie access to about 15 percent of the current jumbo loan market. He notes many with existing jumbo loans will also want to refinance to take advantage of the lower rates. Note that Reed's estimates appear to be based on the old, third quarter price data.

Estimated conforming loan limit increases (revised)

                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

Metropolitan statistical area	Median price Q3 '07	Median price Q4 '07	One quarter change	Estimated new limit
Anaheim-Santa Ana, Calif.	$700,700	$657,400	-6.2 percent	$729,750
L.A.-Long Beach-Santa Ana, Calif.	$588,400	$509,700	-13.4 percent	$637,125
San Diego-Carlsbad-San Marcos, Calif.	$589,300	$522,900	-11.3 percent	$653,625
San Francisco-Oakland-Fremont, Calif.	$825,400	$777,300	-5.8 percent	$729,750
San Jose-Sunnyvale-Santa Clara, Calif.	$852,500	$845,300	-0.8 percent	$729,750
Riverside-San Bernardino-Ontario, Calif.	$376,900	$338,000	-10.3 percent	$422,500
Sacramento-Arden-Arcade-Roseville, Calif.	$335,700	$297,600	-11.3 percent	$417,000
Barnstable Town, Mass.	$400,600	$382,300	-4.6 percent	$477,875
Boston-Cambridge-Quincy, Mass.	$414,600	$380,700	-8.2 percent	$475,875
Boulder, Colo.	$375,800	$371,100	-1.2 percent	$463,875
Bridgeport-Stamford-Norwalk, Conn.	$490,200	$460,200	-6.1 percent	$575,250
Miami-Fort Lauderdale-Miami Beach, Fla.	$346,300	$345,900	-0.1 percent	$432,375
New York-Northern N.J.-Long Island, N.Y./N.J.	$476,100	$457,400	-3.9 percent	$571,750
New York-Wayne-White Plains, N.Y.	$550,900	$523,300	-5.0 percent	$654,125
Edison, N.J.	$391,800	$370,300	-5.5 percent	$462,875
Nassau-Suffolk, N.Y.	$470,000	$461,700	-1.7 percent	$577,125
Newark-Union, N.J./Penn.	$459,700	$435,800	-5.2 percent	$544,750
Seattle-Tacoma-Bellevue, Wash.	$394,700	$377,500	-4.4 percent	$471,875
Wash. D.C.-Arlington-Alexandria, Va./Md./W.V.	$437,600	$400,100	-8.6 percent	$500,125

Source: National Association of Realtors, Inman News analysis

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