San Francisco's Pacific Heights neighborhood is home to the haves, and the have-lesses.
It is a distinction that may seem like a comparison between a Ferrari and Lamborghini to residents of Cleveland, Detroit or the Occupy Wall Street crowds. But it matters to the housing market.
The neighborhood's stretch of Broadway Street is lined with multimillion-dollar mansions with killer views of the San Francisco Bay. Their sweeping vistas are so prized that homeowner Larry Ellison, the world’s fifth-richest man, earlier this year sued his downhill neighbors for letting their redwoods grow tall enough to obstruct the panorama previously visible from his backyard windows.
Just one block uphill, though, where the views may be even more spectacular, sits an unassuming three-story condominium building. It’s graced by a classic awning flanked by sconces, four bay windows, and a metal fire escape painted to blend in with the taupe exterior.
It's inhabited by homeowners of a slightly less wealthy variety — those whom the nation’s lawmakers on Oct. 1 pushed out of the arms of Fannie Mae, Freddie Mac and the Federal Housing Administration, and into the embrace of private lenders.
Residents of the 12-unit Marina-style building also inhabit the rocky territory Congress carved out almost four years ago when it increased the conforming loan limit as part of an effort to rejuvenate the housing market and stabilize prices. Conforming loan limits represent the upper dollar value of loans the government-sponsored enterprises can accept into their portfolios or that the FHA can back.
The decision affected 204, or 6.5%, of the nation's counties, which saw the loan limits rise from as low as $417,000 to as much as $729,750 for FHA loans. Two counties in Hawaii experienced even higher limits for agency-backed loans: $793,750 for Honolulu and $790,000 for Maui County.
That move means homebuyers seeking loans of as much as $729,750 could purchase homes with down payments as low as 3.5% of the purchase price and access the lowest interest rates offered by mortgage lenders, instead of paying the elevated rates associated with higher-value jumbo loans that can’t be resold to Fannie Mae and Freddie Mac.
It also meant when Charles Thies, a portfolio manager at Fisher Investments, bought his two-bedroom condo up the hill from billionaire row in November 2010 for $701,500, his mortgage lender could move the loan off its books by selling it to a GSE. Having access to financing from Fannie Mae and Freddie Mac allows lenders to offer purchasers like Thies better terms and makes consumers more willing to pull the homebuying trigger.
Today, though, if Thies wanted to resell his unit for the same price — or even for a discount of as much as $75,000 — the buyer would have to get a jumbo loan, make a larger down payment and pay a higher interest rate.
And the lender would likely need to hold the loan on its own books, since the debt would be ineligible for purchase by a GSE and an unlikely candidate for securitization, as the market for jumbo residential mortgage-backed securities is moribund. As of late October, just two such securitizations had come to market this year, both issued by Redwood Trust.
It's the have-lesses — those who are potential buyers of Thies's condo and other homes in the same price range — that some economists say must be kept in the housing market via access to conforming loans. Without that access, they argue, many of these buyers will simply sit on the sidelines, prompting sellers to slash their prices and harm an already ailing market.
PRIVATE MARKET REJUVENATION?
One question market observers disagree on is whether the private market can absorb the potential increased volume.
Even though just 1.3% of home purchases and refinance loans are expected to be cut out of the government-backed market by the change, it would still have a significant effect, according to a study from the Federal Reserve.
If the expiration of conforming loan limits had taken place on Jan. 1, 2010, and all the loans made that year still closed, the jumbo market for home purchases would have increased by 50% and the refinance market by 63%, according to data from the Mortgage Bankers Association. Such a change would have boosted banks' portfolio holdings of mortgages by 20%, said the lobbying and research group for the mortgage finance industry.
As of late October there was early evidence the change in loan limits increased the volume of jumbo loans, as MBA research and the central bank study predicted.
Bank of America's third-quarter jumbo loan volume rose by 20%, in part because of the return to lower conforming loan limits, said spokesman Terry Francisco.
"Some of the volume that would have been conforming (loans) got rerouted to jumbo loans," he said.
Proponents of the return to earlier loan limits would see that as a good thing, as they want to see the housing market regain its balance, with private lenders taking on more risk and reducing the government's share of the mortgage market, which currently stands at more than 95% of loans.
The biggest banks already make roughly 80% of the nation's jumbo loans. And with the returns on such loans much higher than what they can earn on the reserves they're required to keep deposited with the Federal Reserve, they're motivated to expand their jumbo loan portfolios as much as possible, says Mike McMahon, managing director at Redwood Trust Inc., a real estate investment trust that packages and sells nonagency residential mortgage-backed securities.
"There's a perception out there that banks aren't buying any loans over $625,500 anymore," he says. "That's not true."
Wells Fargo, Bank of America, JPMorgan Chase, and Citigroup originated $14 billion of jumbo loans in the first quarter, and McMahon sees their lending activity in that area increasing.
Loan applications for "near-jumbo" loans, or those in the $625,500 to $729,750 price range affected by changes in the conforming loan limits, surged more than 40% in April and were up again in June and July, according to MBA data, showing lenders and homebuyers were anticipating the Oct. 1 change.
Because it typically takes 30 to 45 days from the time of application to close a loan, by August most lenders had stopped accepting applications for conforming loans in the "near-jumbo" slice of the market. Total loan applications in this segment fell more than 30% in August, the MBA data show.
Still, McMahon estimated that with jumbo loan rates of 4.5% and costs around 60 basis points, banks are raking in 390 basis points of income on nonconforming loans.
"With a normal upward sloping yield curve, the spread is less than 100 basis points, so banks are loving mortgages right now, especially high quality mortgages," he said.
NOW NOT THE TIME, OPPONENTS SAY
Opponents of the conforming loan change, however, have argued the economy and the housing market are still too weak to allow for an experiment in handing the lending reins back over to the private sector.
The National Association of Home Builders lobbied against the expiration of increased loan limits, arguing that in combination with the qualified residential mortgage standards being proposed by federal agencies, it would keep ownership out of reach for most first-time homebuyers and middle-class households. Under the QRM's 20% down payment requirement, it would take a typical family 12 years to save enough for a down payment on a median-priced single family home, according to the NAHB.
"The housing market is still considered quite fragile," said Mark Willis, a research fellow at New York University's Furman Center for Real Estate and Urban Policy. "Why would you do anything that could possibly weaken the market?"
He pointed to data from Altos Research of Mountain View, Calif., that show home sellers in the highest-priced segment of the market started lowering their asking prices as early as March in anticipation of the adjustment in conforming loan limits.
In the markets tracked by Altos, the share of sellers with high-priced homes who dropped their asking prices started rising in March, climbing from less than 30% of such listings to about 32.5% in late August, the data show.
"Folks wanted to get ahead of the changes," said Scott Sambucci, vice president of data analytics for Altos.
Skeptics of the reduction in conforming loan limits say such price declines are bad news for the economy.
"By reducing demand, these loan-limit changes could lower the value of many homes, sinking more homeowners underwater and making it more difficult for many borrowers to refinance into today's lower rates, the same conditions the federal government has sought to address with other recent policies," said Willis and colleague Josiah Madar in a commentary for HousingWire in late September.
The Mortgage Bankers Association said letting the temporary limits expire would make financing more difficult and expensive for many borrowers and jeopardize the economic recovery in major housing markets.
High-cost areas like California and New York are expected to be the hardest hit by the higher limits, should they remain.
The California Association of Realtors warned in June that more than 30,000 families in the Golden State would face higher down payments, elevated mortgage rates and stricter qualification requirements if the temporary increase in loan limits was allowed to expire.
MBA data from the Pacific region showed it was more affected than any other region, as the number of loans in the price range affected by the loan limit changes jumped to about 4% of the total in August, up from a little more than 2.75% of the total in July.
Monterey County — which includes the wealthy enclave of Carmel, just down the road from the famed Pebble Beach golf course, as well as the depressed farming town of Salinas — suffered the biggest reversal in the nation when the limits changed Oct. 1. The county's FHA and GSE loan limits fell by $246,750, to $483,000.
"No one is hysterical about this yet," said Linda Dorris, president of the Monterey County Association of Realtors. "You're not hearing the hue and cry because the banks have known about this for six months," she said, so lenders and borrowers have had time to adjust.
With interest rates at record lows, even jumbo mortgage rates are at affordable levels for many borrowers. The spread between jumbo and conforming mortgage rates in September had fallen to less than 30 basis points from more than 50 in February, according to data from the MBA.
"Once interest rates go up, prices are going to have to come down," said Dorris, who added that as of October, she hadn't seen much impact on the market. Sales of homes priced over $483,000 were still closing, she said, but buyers were putting more cash into the deals.
SOME SAY PRICES WILL HOLD
Several housing market data research firms, though, say prices are unlikely to be affected by the conforming loan limit change.
"Even in markets that are designated high-cost, sales in the price band between the old elevated limits and the current limits make up only a small percentage of total sales," said an October report from Radar Logic, a New York-based real estate data and analytics company.
Of the 25 metropolitan areas tracked by Radar Logic, the markets with the largest percentage of sales in the “reduction zone” between the old and current limits are New York, San Francisco and San Jose, Calif., and less than 10% of sales in each of those markets will be affected by the reduction in conforming loan limits, the firm said.
Just 24,500 housing units, or 1.1% of the national active housing market, are affected by the conforming loan limit change, according to a report from Discern, an investment analytics firm. Discern's data covers 64% of U.S. ZIP codes; it used those figures to estimate the total impact nationwide of the reduction in conforming loan limits.
And even for those properties, an increase in mortgage rates will have less of an effect on prices than a substantial rise or fall in the amount of homes on the market, according to Brett Kornfeld, an applied strategist with Discern.
"Whether we're looking very local, or MSA city level or nationally, supply is the overwhelming factor affecting home prices in those areas," he says.
REPEAL EFFORTS PUSH FORWARD
Still, federal lawmakers are taking warnings about the economic impact of the conforming loan changes seriously.
Congressmen John Campbell (R-Calif.) and Gary Ackerman (D-N.Y.) introduced a bill this summer to extend the increased limits and, although it did not pass, their counterparts in the Senate were keeping the effort alive this fall. Senators approved a measure in October that would push the extension out to the end of 2013. Passed as an amendment to a spending bill, the measure had to clear two additional hurdles before it could take effect: passage of the underlying bill and a vote to approve it from the House of Representatives.
Amendment co-sponsor Sen. Robert Menendez (D-N.Y.) summed up the reasoning and the urgency behind the measure during the floor debate: "If we want to get the economy moving, the housing market has to be part of it."
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