Good luck buying big city real estate next year «
In just a few weeks, home buyers are going to have a harder time signing up for large mortgages.
The Department of Housing and Urban Development announced on Friday that it will lower the loan limits for its Federal Housing Administration mortgage — a loan used by many first-time and lower-income home buyers — from $729,750 to $625,500. The FHA insures mortgages that banks give to borrowers who make small down payments. Congress raised FHA mortgage caps six years ago in the wake of the downturn.
Home buyers who are impacted will have to turn to the private jumbo market, which has stricter lending standards than the government, including higher down payment and credit score requirements as well as higher interest rates. Each lender decides the terms of these loans, which are held mostly on their books rather than sold to the government, and they vary widely by borrower, typically rewarding home buyers with stellar credit and more cash while penalizing buyers with poor credit and less cash.
Buyers in roughly 650 counties will be impacted by the change, according to HUD. Those who sign up for FHA mortgages of up to $729,750 typically live in expensive cities where even relatively basic single-family homes often run into the millions of dollars. These cities include Los Angeles, New York, San Francisco and Washington, D.C.
To be sure, loans of $650,000 and above make up just a small percentage of the mortgages insured by the FHA. Such loans accounted for just 0.53% of all the mortgages the FHA insured during the third quarter, according to HUD. While small, their share is roughly double what it was in 2009.
The change comes as the federal government begins its exit from the mortgage market. Limits on loans backed by Fannie Mae and Freddie Mac, the quasi-government agencies that purchase most mortgages originated by banks, fell to $625,500 in late 2011.
Since then, a growing number of banks have returned to the private jumbo mortgage market, lending beyond those limits. Originations of these loans has gained steam in the past two years and they are now on pace to hit the highest level since 2007, before the housing meltdown. Lenders gave out $216 billion worth of private jumbos during the first three quarters of this year, up 34% from the same period a year ago, according to Inside Mortgage Finance, a trade publication.
But even though the private mortgage market is opening up, most lenders are very selective. So far, they have been focusing on very affluent buyers with sizable assets (both liquid and in other real estate) who are buying multimillion-dollar homes.
These lenders say they are open to working with less-affluent buyers in expensive housing markets, though such buyers will still have to pass hurdles that are set much higher than the FHA’s rules. The FHA, for instance, will accept borrowers with credit scores as low as 500. But private lenders typically require at least 720. They say they’ll accept a lower score only if there’s something exceptional about the applicant — like if he or she is sitting on a lot of cash or has other assets.
Private jumbos are also more expensive. The average rate on a 30-year fixed private jumbo mortgage stood at 4.49% for the week ending Dec. 6 compared with 4.17% for a 30-year fixed-rate FHA mortgage, according to mortgage-info website HSH.com. On a $729,750 mortgage, that’s roughly $137 more per month and around $49,300 in extra interest over the life of the loan.
There’s another hurdle as well: Borrowers will need to put significantly more cash down with a private mortgage. In most cases, they’ll need a at least a 15% to 20% down payment compared with the 3.5% down payment that the FHA requires — which could shut them out of the housing market. Many buyers turn to FHA because they don’t have the cash that other mortgages require to buy a home.
Going forward, however, experts say it’s possible that some of these borrowers will see cost savings. Lenders will likely begin to lower down payment requirements below the 15% threshold as more buyers are forced to turn to the private market.
Those buyers will then need to sign up for “private mortgage insurance,” which can be cheaper than what the FHA charges. Private jumbo mortgage borrowers can get rid of mortgage insurance after they reach 20% to 22% equity in their home. In contrast, borrowers with FHA mortgages who make a down payment of 10% or less are always paying this insurance—unless they refinance out of the program.
Borrowers who sign up for a 30-year FHA mortgage have an upfront fee of 1.75% of the total loan amount plus recurring annual costs of 1.3% to 1.55% of the loan amount (depending on the size of their down payment), which is paid over a monthly basis as part of their mortgage payment. On a $729,750 mortgage, that’s about $12,770 upfront plus $790 to $943 per month.
Private insurers currently require one type of payment—either an upfront fee or one that’s paid annually over a monthly basis. Depending on the borrower’s credit score and down payment size, the upfront fee can range anywhere from 1.2% to 5.7% of the total loan amount. On a $729,750 mortgage, that’s an upfront payment of anywhere from $8,757 to $41,596. Or if they choose to pay a fee monthly, it ranges from 0.46% to 2.13% or $280 to $1,295.
The large price range underscores the different set of standards in the private market: While the FHA program treats most borrowers the same way, in the private market, borrowers with stronger credit profiles and more cash to put down are rewarded with savings. Meanwhile, those in the opposite situation will be forced to pay more.