The economic stimulus plan agreed on Thursday could unleash a wave of mortgage refinancing that would amplify the effect of the Federal Reserve’s 75 basis-point interest rate cut this week, according to analysts.
While the Fed has cut rates aggressively, until now a large number of homeowners and would-be buyers have not been able to take advantage of the lower interest rates, because of high spreads in the dysfunctional secondary market for jumbo (large denomination) loans.
Under the plan, the so-called conforming loan limit would be expanded for the two government-sponsored enterprises to 125 per cent of area median sales price up to a maximum of $729,750, from a current $417,000.
Now more homeowners will be able to refinance or take out new mortgages in the functioning segment of the market that “conforms” to Fannie and Freddie rules.
The move will also make Fed rate cuts more effective in supporting high value regional property markets such as northern California – where the average home price exceeds the previous Fannie and Freddie limit.
The size of loans for which the Federal Housing Administration could provideloans would also be raised.
Barney Frank, chairman of the House financial services committee, said this “unlocks the upper end of the [mortgage] market” and “takes some of the burden off monetary policy”.
Meanwhile changes to the rules governing the FHA will increase the effectiveness of the interest rate freeze for some subprime borrowers brokered by Treasury. This is because more of these borrowers will be able to take advantage of the freeze to refinance into new FHA loans. “It is a multiplier for what the Fed did” and the “missing piece” for the Treasury rate freeze plan, Mr Frank told the Financial Times.
Yet the benefits come at a price: increasing the role of the GSEs and FHA in the housing market, extending what economists call the “socialisation” of housing finance and raising implicit risks for taxpayers.
In addition, the plan still has its doubters. James Lockhart, director of the office of federal housing enterprise oversight, Fannie and Freddie’s regulator, said it was “very disappointed in the proposal to increase the conforming loan limit” in the absence of “comprehensive GSE regulatory reform”.
Treasury secretary Henry Paulson said he had been run over by a “bipartisan steamroller” in agreeing this element of the package. For his part, Mr Frank said he had pledged that the relaxation of the loan limit would expire in 12 months.
Still, some analysts question whether the GSEs were in any state to take on further credit risk. Karen Shaw Petrou, at federal financial analytics, said a big problem now was the sharp drop in house prices “which means many borrowers have current mortgages well above the actual value of their home”. This meant they could not refinance “because no lender can make a loan and GSEs thus cannot purchase one that comes in well above the current value”.