Late Friday afternoon, in an attempt to bury an important story, the department of Housing and Urban Development (HUD) directed the Federal Housing Administration (FHA) to lower loan limits in high-priced markets.
On January 1, 2014, borrowers will be limited to $625,500 loans in Coastal California. This surprise move will affect houses priced in the $650,000 to $800,000 price range. Borrowers looking to borrower more than $625,500 must use jumbo financing, which usually requires at least 20% down and higher FICO scores.
Previously, a potential buyer of a $765,000 home only needed a $35,250 down payment to complete the sale. Now that buyer must come up with $153,000, and they are subject to much more stringent qualification standards. This will strongly impact the housing market, which is probably why HUD buried this press release by publishing it late on a Friday afternoon.
Ceiling for loans in high-cost areas falls to $625,500
Beginning next year, homeowners with Federal Housing Administration loans will no longer be able to qualify for the $729,750 high-cost area loan limit.
Instead, the Department of Housing and Urban Development is implementing a rule passed a few years back that moves the agency’s standard loan limit for high-cost areas down to $625,500 for all FHA loans.
The standard loan limit for areas where housing costs are low is expected to remain at $271,050, while the ceiling for FHA-insured reverse mortgages will stay at $625,500, HUD added.
I wrote a post detailing How will a reduced loan limit impact Coastal California:
If the FHA also lowers it’s limits [which they did on Friday], the rally in Coastal California real estate will abruptly end. As it stands, people can buy houses up to $750,000 with as little as 3.5% down. If the FHA limit drops, the limit of bids for anyone with less than 20% down will drop along with it.
With so many still underwater, the equity to support a viable 20% down move-up market simply does not exist. The last time the conforming limit was dropped, Irvine, CA witnessed an 84% decline in sales volume in the price range no longer financeable with GSE loans.
The Housing and Economic Recovery Act of 2008 technically changed the ceiling for high-cost areas, but the financial crisis and slow-moving recovery prompted Congress to delay the standard’s implementation.
“As the housing market continues its recovery, it is important for FHA to evaluate the role we need to play,” said FHA Commissioner Carol Galante. “Implementing lower loan limits is an important and appropriate step as private capital returns to portions of the market and enables FHA to concentrate on those borrowers that are still underserved.”
The rule does come with some special exceptions, which HUD outlined in a public letter. These variations allow exempt counties to obtain loan limits above the national standard when applicable.
The rule impacts all mortgage assignments issued on or after Jan. 1, 2014.
Approximately 650 counties will face lower loan limits when the standard takes effect, according to HUD.
The lower FHA loan limit is not the only problem facing the housing market. Lenders will implement the Dodd-Frank requirements in January of 2014. Lenders whine and complain about these new standards, and they try to scare the public with reports of limited credit availability. As lenders implement these new rules, it will curtail lending while they comply. Couple this fact with the new lower conforming limits, and the first quarter of 2014 might be very rocky.
The lower FHA loan limit favors some buyers and handicaps others. Buyers with high credit scores and large down payments should rejoice at these developments. Buyer competition decreases with tighter standards and higher down payment requirements. Buyers shopping in the affected price range should expect motivated sellers and price reductions, and realtor claims of competing offers can largely be dismissed as puffery and manipulation. Buyers should see this as an opportunity to find a bargain. This is a short-term disruption of market equilibrium in the $660,000 to $800,000 price range; it doesn’t signal a long-term price decline.
On the flip side, properties priced under $660,000 will see increased buyer interest and competition. Buyers are now forced to compete for lower priced properties, particularly those who could have financed more than $625,500 but are now limited by the lower loan cap because they don’t have the larger down payment. During the spring I expect another bidding frenzy at prices below $660,000.
The housing market will bifurcate along financing lines. Those buyers with good credit and large down payments will have plenty of choices and limited competition. Those buyers who must use either FHA or GSE financing will face stiff competition. Sometime in 2014, I expect the NAr and homebuilders to mount political pressure, and either the GSEs or the FHA may actually raise the limit — most likely the GSEs with Watt in charge. Ostensibly, any limit increase would be to help potential buyers get homes, but in reality, any increase in loan limits is merely fodder for banks who need inflated prices to bail out their bad bubble-era loans. The political posturing will create more uncertainty making 2014 a rough year for housing.
In the end, I don’t foresee legislators or bureaucrats raising the conforming limit despite pressure from realtors to do so. The impact of the lower limit will be extreme in Coastal California, but those markets are among the strongest in the country. Raising the conforming limit merely contributes to a bubble in Coastal California. Since the rest of the country avoids the impact, and since Coastal California risks an echo bubble, I believe legislators or bureaucrats will wisely leave these limits alone; in my opinion, they will probably continue to lower loan limits as private money enters the market.
Many readers of this blog actively look for homes for their families. This is the group most impacted by lender can-kicking. This fact will become painfully obvious when the market bifurcation problem appears.
Banks should have processed their bad loans through foreclosure and sold the REO at market prices. That would have cleared the market of bad debt and allowed what’s known as “price discovery” to take place. During the housing bubble, houses were mispriced; Lowering interest rates alone did not make peak prices viable. Lenders chose to suspend a significant portion of our housing stock in the clouds where only move-up buyers can reach them. Unfortunately, with the loss of equity through lower prices and rampant mortgage equity withdrawal, the move-up market is not viable, so 20% to 40% of our supply waits in limbo for higher bids that are not forthcoming.
When you see the plethora of homes prices above $660,000 — out of reach for most buyers due to a lack of down payment money — those home represent supply that should be made available at lower prices to balance supply and demand. Instead, it will remain in the clouds.
When discussing supply and demand in the future housing market, distinguishing between home prices above the limit and below the limit becomes very important. Below the limit, demand will be very high while supply is very low. Above the limit, demand will be very low while supply is very high. Ordinarily, large supply and weak demand would cause prices to drop; however, since that supply is cloud inventory, prices can’t drop. The conforming limit plus lender cloud inventory policies create this market imbalance that market forces cannot correct on their own. Based on current bank behavior, lenders will screw future buyers and force them to pay manipulated market prices in order to make up for the horrible mistakes lenders made during the housing bubble.
Today’s featured property demonstrates lender can-kicking. The former owners bought near the peak and couldn’t afford the property. They put nothing down, so it wasn’t a financially painful loss when they stopped paying the mortgage. With prices 25% higher than they were two years ago, the bank stands to recover about $200,000 more than they otherwise would have if foreclosure processing had continued until the bad debts were purged.
At least that’s how the bank hoped it would work out.
Since the conforming limit just dropped, the buyer for this property must come up with a $150,000 down payment rather than a $35,000 one. Obviously, many more potential buyers have $35,000 liquid savings than have $150,000; therefore, the potential buyer pool for this property just shrank considerably. And since this is a bank-owned property, they will lower price until they sell it. If this doesn’t go into escrow in December, I expect to see a $50,000+ asking price reduction to find a motivated buyer.
22441 FOREST Hl Lake Forest, CA 92630
$749,500 …….. Asking Price
$785,000 ………. Purchase Price
8/31/2005 ………. Purchase Date
($35,500) ………. Gross Gain (Loss)
($59,960) ………… Commissions and Costs at 8%
($95,460) ………. Net Gain (Loss)
-4.5% ………. Gross Percent Change
-12.2% ………. Net Percent Change
-0.5% ………… Annual Appreciation
Cost of Home Ownership
$749,500 …….. Asking Price
$149,900 ………… 20% Down Conventional
4.52% …………. Mortgage Interest Rate
30 ……………… Number of Years
$599,600 …….. Mortgage
$154,023 ………. Income Requirement
$3,045 ………… Monthly Mortgage Payment
$650 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$156 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$128 ………… Homeowners Association Fees
$3,979 ………. Monthly Cash Outlays
($741) ………. Tax Savings
($787) ………. Principal Amortization
$251 ………….. Opportunity Cost of Down Payment
$114 ………….. Maintenance and Replacement Reserves
$2,817 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$8,995 ………… Furnishing and Move-In Costs at 1% + $1,500
$8,995 ………… Closing Costs at 1% + $1,500
$5,996 ………… Interest Points at 1%
$149,900 ………… Down Payment
$173,886 ………. Total Cash Costs
$43,100 ………. Emergency Cash Reserves
$216,986 ………. Total Savings Needed