Conforming loans meet the criteria for federally backed mortgage institutions such as Fannie Mae and Freddie Mac. Mortgage lenders and borrowers prefer conforming loans due to their low interest rates. The Federal Housing Finance Agency (FHFA) sets the dollar limit for conforming loans yearly. Below are the major factors the agency uses to set the limits.
Housing Market Conditions
The housing market changes a lot due to multiple factors. For example, a property market may experience an extended period when property prices generally rise. If that happens, the FHFA may raise its loan limits to enable buyers to afford loans and buy houses. Such a situation may arise if developers have fewer properties on the market that cannot meet the demand.
Home Price Indices
The House Price Index (HPI) tracks several parameters related to the residential property market. The index considers different issues, including:
- Residential mortgage defaults
- Mortgage prepayments
- Residential property availability
- Residential property prices
The HPI is a crucial tool in loan limits since it provides insights into home affordability. For example, the FHFA can use the index to determine whether homebuyers can afford the available loans with the current limits.
Inflation and Interest Rates
Inflation and interest rates directly affect home affordability and price. For example, inflation increases the cost of building materials, forcing developers to hike their home prices. A home that cost $500,000 last year might cost at least $25,000 more this year with 5% inflation.
If the above scenario happens, then you might not afford the same house you could afford last year if your loan limit stays the same. An increased loan limit may help you afford the same property.
Regional Differences
Conforming loan limits are not uniform across the country. The variations make sense because property prices and markets vary by location. Prime states (in terms of housing markets) like Hawaii have predominantly higher property prices than others. Thus, a home costing $500,000 might cost more in some states than home costs in Hawaii.
Changes in home prices or affordability vary by location. The calculation for conforming loan limits incorporates these regional variations. For example, a prime market might witness a bigger price change than others in a given year.
Property Type
A uniform loan limit for all property types would not make sense since different properties attract different prices. For example, condominiums (condos), single-family homes, and multi-unit homes all attract different prices. As such, a single-family home (that attracts high prices in many areas) might get a higher loan limit than a condo in any given year.
Mortgage Market Stability
The mortgage market is a slave to several factors that change over time. Loan demand, inflation, property prices, and real estate laws affect the mortgage market. Unfortunately, too much instability is bad for the market since the players (like home sellers and buyers) cannot confidently operate.
For this reason, the FHFA sometimes adjusts loan limits to stabilize the market. For example, if mortgage rates increase too much, the FHFA may raise its limits to enable more people to buy homes.
Government Legislation or Regulation
Lastly, direct government action can determine whether the FHFA increases, lowers, or maintains the loan limit. For example, the U.S. Congress might decide to enact property laws addressing specific issues, like the availability of low-income houses. Similarly, individual states might enact new regulations affecting home prices. Such changes may affect overall loan limits.
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