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Larger mortgages for lower rates

You’ve heard a lot about the rise in housing prices across the country. To reflect that increase, the so-called conforming limit on mortgages -- that is the maximum loan size that Fannie Mae and Freddie Mac, the largest provider of funds for home mortgages in the country, may buy -- has been heading upward for more than a decade. But the 2006 increase is a record breaker. This is important because the conforming limit is also the maximum amount a mortgage can be before it becomes a higher-cost jumbo loan.

New conforming limit
On January 1, 2006, the conforming limit for mortgages on single-family dwellings in the continental U.S. climbed to $417,000 from $359,650. (The limit is 50 percent higher in Alaska, Hawaii, Guam and the U.S. Virgin Islands.) That’s an increase of almost 16 percent over 2005, the largest-ever leap in a single year. To put it in perspective, the average annual increase over the last 25 years has been 5.6 percent. And the last time increases even approached this level was in the late 1980s, when the conforming limit went up by double digits four years in a row.

Why borrowers benefit
To understand why this increase is good for borrowers, a bit of background is necessary. The conforming limit is set by Fannie Mae and Freddie Mac, the federally chartered companies that help keep the mortgage market healthy. They do this by purchasing mortgages from banks and other lenders and reselling them to investors.

Fannie Mae and Freddie Mac will only purchase mortgages that meet certain conditions, one of which is that the principal must be below the conforming limit. This limit is adjusted every year, if necessary, to reflect any rise or fall in average housing prices. A rise in the conforming limit helps borrowers to:

  • Avoid jumbo mortgages: Many lenders will approve mortgages higher than the conforming limit, but these loans -- called jumbo mortgages -- carry a slightly higher interest rate. The difference may be as much as half a percentage point, though it’s typically around one-eighth to one-quarter of a percent more than a fixed-rate conforming mortgage. Jumbo loans carry more risk to the lender and usually involve extra underwriting requirements, and these costs are passed along to the borrower.
  • Save on interest payments: The big increase in the conforming limit is good news for home buyers, particularly those looking at homes priced between $359,650 and $417,000. In 2005, a mortgage of $400,000, for example, would have been considered a jumbo loan and would have carried a higher interest rate. In 2006, a loan that size is well under the limit and is therefore likely to carry a more competitive rate. For a 30-year fixed rate mortgage, the difference of a quarter of a percent works out to almost $64 per month.
  • Refinance and save: If you’re a homeowner who took out a jumbo mortgage when the limit was lower, you may now be able to refinance and obtain a conforming mortgage at a lower rate.

The rise in the conforming limit will not necessarily affect the size of loan for which you will be approved, however. Remember also that low interest rates shouldn’t tempt you into buying more home than you can afford.


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