Cap on FHA Loans Will Hit City Borrowers Hardest

Beginning on January 1st, borrowers will have more difficulty obtaining a higher mortgage.

On Friday, the Department of Housing and Urban Development announced it will lower FHA loan limits from a maximum of $729,750 to $625,500. FHA mortgages are a popular option for first-time and lower-income borrowers, and this move decreases the maximum loan amount by over $100,000. This limit applies to one-unit homes in the high-cost areas of the country.

It was six years ago that Congress increased FHA mortgage caps to bolster the industry, as banks decreased lending to home buyers with small down payments. Congress had planned to lower FHA limits under HERA in 2009, shortly after the increase under the Economic Stimulus Act of 2008, but this move was delayed until now.

In low-cost areas, the standard loan limit will remain at $271,050. The FHA stated that it intends to focus more heavily on lower income borrowers, not high-income earners who want to take advantage of low rates and down payments. Anyone can currently apply for an FHA loan, and the agency has made no indication it plans to change this.

This news means that borrowers who want to borrow over the cap must turn to the private jumbo market instead, which has far stricter lending standards than the federal government, as well as higher credit score and down payment requirements. The private market also comes with higher interest rates.

Jumbo loans are typically held on the lender’s books and not sold to the government, so each lender decides the terms, which tend to vary widely. Borrowers with the best credit scores and more cash for a down payment will see the least impact.

Loan limits in about 650 counties will be lowered started January 1, 2014. Borrowers who obtain an FHA loan near the old cap usually live in more expensive cities like New York, San Francisco and Los Angeles, where even basic single-family homes may run into the millions.

Loans of $650,000 or more account for a very small percentage of FHA insured mortgages; only 0.53% of mortgages insured by the FHA in the third quarter, according to HUD. This is double the share of these larger loans compared to 2009.

More lenders have returned to the private jumbo loan market, lending beyond FHA limits. This trend has increased over the past two years and is expected to hit the highest level since 2007. Lenders increased private jumbo lending by 34% over last year, according to Inside Mortgage Finance.

Lenders remain selective, however, with the majority focused on affluent home buyers with plenty of assets buying multi-million dollar homes.

The average rate on a 30-year fixed-rate private jumbo loan was 4.49% last week, compared to 4.17% for a 30-year fixed-rate FHA loan. On a loan of $729,750, that adds an extra $137 to the monthly payment and more than $49,000 in interest over the life of the loan.

With more buyers, particularly city dwellers, forced into the private market, this is an opportunity to save money, according to a recent Market Watch article.

Buyers will need to get private mortgage insurance, which is often cheaper than the mortgage insurance fee charged by the FHA. Private jumbo loan borrowers can also drop the insurance after reaching 20-22% equity in the home, whereas borrowers with an FHA loan who make a down payment under 10% must always pay the insurance unless they refinance out of the program.

A 30-year fixed-rate FHA loan comes with an upfront fee of 1.75% of the total loan plus annual costs of 1.3% to 1.55%, paid on a monthly basis and added to the mortgage payment. This adds up to $12,770 upfront on a $729,750 loan, along with $790 to $943 per month.

Private insurers require either a fee paid annually on a monthly basis, or a single upfront fee, not both. The cost depends on the down payment and the borrower’s credit. The upfront cost ranges from 1.2% to 5.7%, which is between $8,757 to $41,596 on a $729,750 mortgage. Borrowers who choose a monthly fee will pay 0.46% to 2.13%, or $280 to $1,295 per month.

This means that, while things seem dire for city dwellers hoping for a large FHA loan in the near future, there is the potential to see greater cost savings in the private market, but it all comes down to credit ratings and cash on hand.