Starting October 1, the maximum loan amount from Fannie Mae and Freddie Mac will drop from $729,750 to $625,500.

The correct amount is zero because government should not be in the mortgage business at all. However, this is a small step in the right direction and it will increase costs of mortgages that exceed the maximum.

Reuters reports Home buyers try to beat “jumbo” loans squeeze

It was only in recent years that the loan limits went so high. Mortgages that are too big to be sold to Fannie and Freddie are termed jumbo loans and are backed privately. Until 2008, all home loans over $418,000 were considered jumbo loans. In that year, a stimulus-focused Congress twice raised the limit on loans the government would back in high cost areas, first to $625,500 permanently, and then to $729,750, temporarily.

Since then, Fannie and Freddie have backed an increasing share of that market. In 2010, so-called “jumbo conforming” loans, those over $417,000 and government-backed, made up 6.73 percent of loan originations, according to CoreLogic.

That top temporary limit was extended twice, but is expected to expire at the end of September.

Private lenders are preparing to step in, according to Guy Cecala of Inside Mortgage Finance, a research firm. In the last quarter of 2010, private lenders originated more loans over $417,000 (the traditional jumbo market) than did government agencies, he said.

Investors like the fact that jumbo loans tend to be safer and more profitable than smaller ones. The privately-backed mortgages require bigger downpayments (currently about 30 percent of the home’s value, instead of the 20 percent more typical in less expensive loans), which adds security.

Also adding to their allure, the loans carry higher interest payments; the spread between the so-called conforming loans backed by Freddie and Fannie and jumbo loans is running about 0.5 percentage points higher, said Cecala. Furthermore, a higher proportion of jumbo loans are made on a variable rate basis, which is less of burden for holders, Cecala said.

The article tells a sop story of a couple rushing to buy now ahead of the increase because the two bedroom house they live in will soon not be big enough because a child is on the way. The couple only wants to put down 10%.

For every person rushing to buy a bigger house now, there will be others who will simply be priced out. More importantly, if there is a “rush” of any nature between now and October, there will be a vacuum of buyers later, with falling prices as a direct consequence.

Regardless of which way it plays out between now and September, it will be increasingly more expensive and require a bigger down payment to get a jumbo-sized loan starting in October. This will have a dampening effect on home prices.

Mike “Mish” Shedlock
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