George Washington University Study Finds That FHA Loan Limits Are Too High

Dennis Norman St Louis

“FHA still could serve 95 percent of its historic targeted market even if the maximum FHA loan limits were reduced by nearly 50 percent.”

Last week, George Washington University released a report, “FHA Assessment Report: The Role and Reform of the Federal Housing Administration in a Recovering U. S. Housing Market,” in which it revealed that the Federal Housing Administration’s (FHA) current loan limits are larger than necessary to serve its targeted market of first-time and low to moderate income borrowers. The study finds that the Obama Administration’s current proposal to reduce the higher end of FHA’s loan limits would have a small impact on its current market share and that larger changes are needed as FHA phases out its recent role as lender of last resort.

The report states that “the FHA still could serve 95 percent of its historic targeted market even if the maximum FHA loan limits were reduced by nearly 50 percent.” The study indicates FHA’s market share is currently at about 30 percent of all loan origination’s and, in order to serve its target population, only needs a market share of between 9 to 15 percent.

“FHA’s expansion played a major role in keeping the housing market afloat during the economic collapse of 2008 and 2009,” said Robert Van Order, co-author of the report. “However, we now are left with large loan limits that were set when home prices at the top of the bubble. They don’t reflect current market conditions and are unlikely to assist the FHA in reaching its historical constituencies – first time, minority and low income homebuyers. ”

FHA’s loan limits have risen rapidly since the credit crunch began. In 2006, the FHA could insure loans of up to $362,790 in the higher cost markets. In response to the 2008 housing crisis, FHA loan limits were revised to insure loans of up to $729,750 in these high cost markets. Recently, the Obama Administration has proposed allowing current law to lapse in October, causing a modest decrease in these limits to $629,500.

“We find that FHA’s current market share exceeds what is needed to serve these markets,” said Dr. Van Order. “In the wake of significant declines in home prices, we believe the FHA could reduce its loan limits by approximately 50 percent and still almost entirely satisfy its target market. That would reduce its currently large market share, which is difficult for FHA to manage.”

The report analyzes the size of FHA’s target audiences to determine appropriate limits. It concludes that an FHA limit of $350,000 in the high cost markets and a limit of $200,000 in the lowest cost markets is sufficient to satisfy more than 95 percent of FHA’s target constituency. Additionally, the report finds that the Administration’s proposed reductions in loan limits would affect only three percent of loans endorsed in calendar year 2010.

In order to address this problem the report recommends that Congress and the administration take the following actions in the below order:

  • Reduce FHA’s loan limit in the lowest cost markets from the current $271,050 to $200,000.
  • Return the FHA loan limit in high cost markets from $729,750 to $363,000. This would be achieved by reversing the current policy that allows FHA to guarantee loans of up to 125 percent of the median home price in high-cost markets.
  • Return to using current area median home price in calculating the local loan maximum, moving away from the 2008 median home price estimate.
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