FHA Loan Limits Get a Boost, but Will It Help Housing Market?

FHA Mortgage Cap Raised, but at What Cost?

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Seeking to strike a balance between shoring up the struggling housing market and dialing down government involvement, the House and Senate voted Thursday to approve a bill raising the maximum size of mortgages the Federal Housing Administration can insure. 

The measure now goes to the president for final approval, which he's expected to sign Friday as part of a larger package of spending bills. 

Passage of the bill would allow borrowers in pricey markets seeking loans up to $729,750 to take out an FHA-backed loan, which requires a lower down payment than "jumbo" loans, which usually also carry higher interest rates. The bill would not affect loans guaranteed through Fannie Mae or Freddie Mac.

The limits for Fannie-, Freddie-, and FHA-backed loans were raised when credit markets tightened during the financial crisis, but they automatically reverted to the lower ceiling of $625,500 October 1, impacting some 670 counties. As a result, prices tanked in some of the nation's pricier markets due to the lower limits, prompting lawmakers to reconsider raising the cap once again. [Are Things Looking Up for the Housing Market?]

"The issue became, how do we avoid this pitfall and bring stabilization to prices in the housing market," says Cameron Findlay, chief economist at LendingTree. "The government's not trying to stimulate prices higher. At this point, they're trying to slow the decline."

Proponents of the increase argue that the housing market is still much too feeble to withstand any obstacles that make it more difficult or expensive to take out a loan. But critics say the measure would primarily benefit affluent neighborhoods, synthetically drive prices higher, and reinforce the government's already giant presence in the housing market.

Nevertheless, most experts agree that reducing the government's footprint in housing and resuscitating the virtually nonexistent private sector's presence is the right direction in the long term. The government-sponsored enterprises Fannie and Freddie are expected to pull back from their involvement in the housing market in the near term, but because the housing market remains so weak, there will be a void to fill.

"What you're going to see is FHA having to step up to fill that void," Findlay says. "If I'm somebody in that bucket between $625,500 and $729,750, I'm probably somebody who wants to go with FHA right now. And basically, that's everybody in California, Florida, and New York. That's a large percentage of the market right there."

The concern, again, is that FHA's market share will balloon, further entrenching the government in the housing market.

Another unintended consequence of the higher loan limits is more borrowers with high-dollar loans with very little "skin in the game." FHA-backed loans only require a 3.5 percent down payment. "FHA levels were restored to their previous levels, but GSE levels were not," says Greg McBride, senior financial analyst at Bankrate.com. "You could take a jumbo loan and pay 20 or 30 percent down, or take an FHA loan and only put down 3.5 percent. There's really not that middle ground anymore."

As the tug of war continues between reducing the government's footprint in housing and ensuring the market can stand on its own, the ultimate outcome of raising FHA loan limits remains unclear. A recent audit raised concerns about FHA's financial situation and found the agency's cash reserves alarmingly low.

"If I look at it from the standpoint of a homebuyer, it's great for them," Findlay says. "If I look at it from the standpoint of our economy and the long-term sustainability, maybe it's not good [in the long term] but it's OK for now."

mhandley@usnews.com