5 Reasons Why Congress Should Let the High-Cost Mortgage Limits Expire

Few home buyers will be affected, and the ones that are can afford a slightly more expensive loan

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As October 1st grows nearer, realtors in places like San Francisco and New York City are beginning to sweat. Unless Congress acts before that date, the government will be unable to guarantee mortgages in excess of $625,500. Since 2008, it could back mortgages as big as $729,750 in certain high-cost areas. Legislation to prevent this decline in mortgage limits might not succeed by the end of the month, but that's okay.

For some background on the change that will occur, check out this post. I would suggest five reasons why Congress should allow the old limits to expire.

No One With a Mortgage Greater Than $625,500 Needs a Subsidy

First, let's think about who keeping the mortgage limit high helps: relatively affluent individuals. At this time, around 66% of Americans own a home. It's safe to say that this is approximately the top 66% most affluent. Now consider that the metropolitan statistical area with the highest median home price is Honolulu, HI, according to the National Association of Realtors. The median price was $607,600 at the end of 2010. If you consider that most banks will require at least 5% down, then this maximum median mortgage would be no more than $577,220.

What does this tell us? That at least half of the population of homeowners will continue to be able to continue to qualify for conforming loans. That leaves those no more than the other half of homeowners potentially being forced to obtain mortgages without the government's blessing. They would be the wealthiest 33% of Americans. In fact, it's probably an even smaller portion of the top than that, considering the generous approximations made above.

The question becomes: does the government really need to subsidize the mortgages of the richest one-third of Americans? It's hard to see why. Surely, these people will still be able to get mortgages without a government backing, either through a larger down payment or a higher interest rate. They can afford either.

In Many Areas, Prices Have Declined More Than the Limit Would Drop

The previous conforming limit was set in 2008 based on 2007 prices. Unless you've been in a coma for the past three years, you know that home prices have dropped significantly in many markets -- particularly many of the markets that boasted the highest prices in 2007.

In San Francisco, for example, from 2007 to 2010, the median home prices dropped from $804,800 to $567,900. I know, ouch. That's a 29% decline. Meanwhile, the conforming loan limit will fall from $729,750 to $625,500 -- a decline of just 14%. In other words, the average borrower is still better off with the new conforming loan limit than they were with the old one in 2008.

High-Priced Homes Are a Relatively Tiny Part of the Housing Market

The above analysis implies something else: there aren't all that many homes out there for sale that would even require mortgages in excess of the new conforming limits. You can see this clearly enough through the fact that median home prices have declined a lot more over the past three years than the conforming limit would.

You can also look at new home sales to get some idea of how few home sales would be affected by cutting the conforming limit. In 2010, just 15% of new homes sold cost more than $400,000. And many of these were likely in high-cost areas, where the limit would remain $625,500. The portion of the year's sales that were over $500,000 was just 9%. And remember, the vast majority of sales of more expensive houses would still occur, since these buyers can afford to pay a little more.

Higher Limits Won't Help First-time Buyers -- Or the Housing Market Recovery

The population who can do the most to help the ailing home market is first time buyers. They're the ones who can help to work through the massive housing market inventory. Current buyers will just create churn when purchasing new homes. Yet few first time buyers will look to purchase a home well above their city's median home price. After all, most people who could afford to purchase a relatively expensive home would have already done so years ago.

You could argue that the new limits might keep current homeowners in their relatively less expensive homes for longer, preventing the availability of their less expensive home for a first time buyer. But this argument doesn't really hold up for one key reason: there's plenty of inventory out there. In most markets, first-time buyers who want to find a home within a modest budget can do so. In markets where they can't, the lack of inventory implies that these cities aren't a part of the problem anyway.

This Will Make for a Good Experiment

Finally, seeing how the market reacts to this change will serve as an important demonstration to policymakers. If they see the new limits have relatively little impact, then this will provide greater certainty that beginning to wean the housing market off of government support won't cause its collapse.

At this time, few policymakers believe that the government should continue to back nearly all new mortgages. Allowing the conforming limit to drop modestly is an important first step in the process of taking the training wheels off. Although we would be foolish to expect the government to take its hands out of the housing market entirely, it should at least stop subsidizing homeownership for the relatively affluent.

Image Credit: REUTERS/Mario Anzuoni