An In-Depth Look at Loan Limits: How, When and Why
When mortgage lenders issue a home loan they do so in part with having the ability to sell that loan in the secondary market. Long gone are the days when a bank or mortgage company approved a loan and then profited from that mortgage by collecting interest each and every month over the term of the loan. During that period, the loan would be profitable for the lender after a few years have passed. Mortgage companies expend a lot of personnel capital during the evaluation process. Yet for decades that’s how lenders made money issuing mortgages. Then, banks created most of the mortgage loans and collected the interest with the goal of obtaining more business from the borrower such as savings, checking and installment loans.
That also meant lending guidelines from bank to bank could vary greatly. One bank could turn down a mortgage application while another would approve it under the very same circumstances. The Federal Housing Administration, or FHA, provided universal guidelines lenders could follow in 1934. By doing so, should the loan ever go into default the lender would be compensated for the loss. But the FHA also provided another avenue of profit for banks when these universal guidelines were used: loans could be sold to one another. Suddenly, banks could turn a short-term profit on a home loan by selling it at a discount without having to wait several years to break even.
During the 1930s and 1940s populations largely were concentrated in major metropolitan areas. Places such as New York, California, Florida and Texas were the largest beneficiaries of these universal guidelines as the number of home loans issued in large cities in these states far outpaced other regions of the country. In addition, someone applying for an FHA loan in New York City would be evaluated using the very same set of lending guidelines as someone applying for a home loan in Miami, Dallas or Los Angeles. There could be some slight differences between how banks approve an FHA loan for example but these differences could not override required guidelines set forth by the FHA.
For example, while FHA loans ask that debt to income ratios be somewhere in the neighborhood of 33 percent for housing payments and 41 percent for total credit obligations, there is no “wiggle room” lenders can employ based upon other factors in the loan file. Credit histories can vary from borrower to borrower as well. But some guidelines simply cannot be ignored or altered. One of these most important guidelines relates to loan limits. From California to New York, loan limits are strictly enforced if the lender has any intentions of selling the loan in the secondary markets.
All conventional loans today have loan limits whether it’s a conforming loan issued using Fannie Mae or Freddie Mac guidelines, VA or FHA loans…limits apply. But who sets these limits? When are they set and why? Let’s take a closer look at each for answers.
FHA loan limits are set a little differently compared to other programs. FHA lending is much more local compared to say a Fannie Mae or Freddie Mac loan. This means loan limits can be one amount in one county but higher or lower in an adjacent one. These limits change every year, most usually anyway and are the FHA bases its annual loan limits on the local median home value for the area. As home values increase from year to year, the FHA loan limit can also change year to year right along with home values. This takes into consideration price appreciation of homes while still providing affordable financing options for consumers. Currently, the loan limit for most parts of the country, regardless of median home values for the area is $271,500. Each year, the FHA reviews the median home values in each area and multiplies that amount by 115%. If the median home value for a county is $100,000, then the maximum FHA loan limit is set at 115% of $100,000, or $115,000. This limit is established for a single family home.
While FHA loans can only be used to finance an owner-occupied property the program can also be used to finance a duplex or 2-4 unit property as long as the borrower occupies one of the units as a primary residence. For a duplex, the limit is $362,950. A three-unit property is limited to $426,625 and a fourplex at $530,150.
Okay, but what about those higher cost areas we mentioned earlier such as New York City, Miami or Los Angeles? The FHA also makes allowances for areas that are deemed “high cost” and adjusts the maximum loan amount accordingly. A single-family home loan limit is $636,150, a duplex at $814,500, three unit at $984,525 and the fourplex at $1,223,475. High-cost loan limits for FHA loans are the very same as the conforming loan limit set each year by Fannie Mae.
VA Loan Limits
VA loan limits are based upon the borrower’s entitlement, but with a twist. A VA loan does not require a down payment and for those who are eligible for a VA loan and want to come to the closing table with as little as possible there really is no better loan option. VA loan limits can be set individually based on what is referred to as “entitlement.” Today, the entitlement is $36,000. And just like the FHA program, there is a loan guarantee to the lender. Should the loan ever go into default the lender is compensated at 25% of the loss.
Eligible borrowers for the VA home loan include veterans of the armed forces, active duty personnel with at least 181 days of service, National Guard and Armed Forces Reserves with at least six years of service and surviving spouses of those who died while in service or as a result of a service-related injury. To determine this eligibility, the lender obtains a copy of the Certificate of Entitlement, or COE. The COE will list the amount of available entitlement.
To arrive at the maximum entitlement with the 25% guarantee in mind, the maximum loan amount would be four times $36,000, or $144,000. But that’s not very much in most parts of the country. In areas where home values are higher than the maximum entitlement amount, the VA limit is set to match the conforming loan limits currently set at $424,100.
And, just like the VA home loan, loan limits will rise based on the number of units up to four as long as the borrower occupies one of the units as a primary residence. The maximum VA loan limits are $424,100, $543,000, $656,350 and $815,650. High-cost allowances are also made in areas where the median home value is higher compared to other parts of the country. The VA maximums in these areas are $636,150, $814,500, $984,525 and $1,223,475.
Conforming Loan Limits
Conforming loans are conventional mortgages approved using guidelines established by Fannie Mae and Freddie Mac. While there is no government or program guarantee to the lender who approves a conforming loan, the loan is, however, eligible for sale in the secondary markets, either to other mortgage companies or directly to Fannie Mae or Freddie Mac. Conforming loans by far command most of the market share with nearly two out of every three mortgage loans approved today is conforming loans.
Fannie and Freddie loans can also finance non-owner occupied properties such as rentals, beach or vacation homes, unlike FHA and VA loans which can only be used to finance a primary residence.
Each year, the Federal Housing Finance Agency, or FHFA, reviews the national average for median home values. If there is an increase from one year to the next, the conforming loan limit will be adjusted accordingly. If there is no increase or values actually fall from year to year, there will be no adjustment. Values are reviewed each October with the new limits released in late November. The current conforming loan limits are $424,100, $543,000, $656,350 and $815,650 and $636,150, $814,500, $984,525 and $1,223,475 in high cost regions.
You may have also heard the term “jumbo” as it relates to financing a home. Jumbo loans are simply loans where the amount is higher than the local conforming loan limit. Remember, loan limits cannot be adjusted by an individual lender but must be strictly followed. Jumbo loans are approved in pretty much the same manner as any other loan program as it relates to credit, income and employment with the primary differences being the amount and terms.
Jumbo loans will require a down payment of at least 10% of the sales price but the most competitive interest rates for jumbo loans are those with a down payment of at least 25% of the price of the home. There aren’t as many jumbo loans issued compared to conforming and government-backed mortgages and there really isn’t as robust of a secondary market where lenders can sell these loans. Instead, individual lenders establish their own jumbo guidelines allowing other mortgage companies to approve a jumbo loan using those guidelines, and then the mortgage company issuing the approval can sell to the lender who released them.
In most parts of the country, jumbo loans start at anything above the conforming limits with a maximum jumbo loan amount around $2 million, yet this can often be a subjective maximum amount. One lender may cap a jumbo loan at $1 million while another mortgage company can offer a jumbo loan with a limit of $2 million.
There is another so-called “objective” jumbo loan limit loosely referred to as a super jumbo loan. A super jumbo mortgage loan limit is one that is higher than competing jumbo limits offer. For example, a lender can offer a jumbo mortgage with a $1 million limit and offer another super jumbo mortgage with a limit of $5 million. Some mortgage loans in the super jumbo category can also fall into the “portfolio” category. A portfolio loan is one where the lender has no intention to sell the loan but instead collect the monthly payments and keep the loan in its “portfolio.”
Guidelines for super jumbo can change based on the lender issuing approval requirements. As long as a mortgage company using predetermined super jumbo guidelines the loan can be sold to the lender that offers the program and buys the loan from the originating mortgage company.