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What Do The 2007 Mortgage Loan Limits Mean For You? Peter G. Miller - Mortgage Lenders Plus.com Add to Delicious, diggit, reddit, technorati favs

The new loan limits for 2007 are out and -- ta da -- they're the same as 2006. But don't let such financial sameness fool you, loan limits are important and what you know about them could save you big dollars.

In basic terms, for 2007 you can borrow as much as $417,000 in most areas and have a "conforming" or "conventional" loan. However, if you borrow above the conventional loan limit, perhaps if you borrow $425,000, then you have a "jumbo" loan and face a higher interest rate.

How much higher?

Let's say you borrow $417,000 at 6.15 percent. The monthly cost for principal and interest over 30 years is fixed at $2,540. Borrow $425,000 with the same loan program and the same credit status and you might pay 6.40 percent. Now your monthly payments will rise to $2,658.

So borrow just $8,000 above the conventional loan limit ($425,000 less $417,000) and your monthly payment will increase $118 a month or $1,416 in the first year of the loan term.

That sure seems like a steep cost increase -- and it is. A better choice is either to borrow less by putting up more cash or by getting two loans -- a first loan below the mortgage loan limit and then a second mortgage for any additional financing. For instance, in our example you could borrow $417,000 at 6.15 percent and get an $8,000 second loan at 6.4 percent. The monthly cost for the second loan: $50. That's an initial savings of $68 a month or $816 a year, money better spent paying off principal instead of interest.

Why is the cost for the jumbo loan so high? Because the steeper interest rate for jumbo financing is being applied to the entire $425,000 loan, not just the additional $8,000 above the conventional loan limit.

How Loan Limits Work -- And Why

While borrowers look at such mortgage issues as rates, costs and terms, lenders look at loans differently. To borrowers a loan is a liability but to mortgage lenders a loan is an asset, an asset that under the right conditions can be sold.

The ability to sell a loan is important to lenders because if loans can be sold it means that lenders have fresh cash. With new cash lenders can make additional loans and those extra mortgages produce more fees, more interest and more profit.

The catch is that not all mortgages can be sold. The loans wanted by investors, insurance companies, pensions, mutual funds and others must meet certain conditions. These conditions are reflected in the underwriting guidelines for each loan product. For instance, one loan might require a certain interest rate, credit score, minimum down payment or loan-to-value (LTV) ratio while another loan may have different standards. Investors look at each mortgage product and make bids which depend on the attractiveness of individual loans.

One of the most important standards concerns the mortgage amount. Loan buyers prefer loans of a certain size, but not larger. The logic is that loans above the basic level represent more risk. Of course, where there's more risk there are also higher mortgage rates -- that's why the jumbo loan in our example had a .25 percent premium. In practice, the premium may be higher or lower depending on the market, the loan product and other factors.

Loans which meet the standards necessary to be quickly sold are called "conforming" or "conventional" mortgages. Bigger loans are called "jumbo" mortgages.

The decision to establish the conventional loan limit is largely made by the Office of Federal Housing Enterprise Oversight. OFHEO is a government agency that oversees Fannie Mae and Freddie Mac, the two largest mortgage purchasers.

Fannie Mae, Freddie Mac and other mortgage buyers form what is known as the "secondary market." Fannie Mae and Freddie Mac buy loans from local lenders. The cash from Freddie Mac and Fannie Mae allows the local lender to make those profitable new loans. As to Freddie Mac and Fannie Mae, they get the money to buy local loans by selling mortgage-backed bonds and securities to Wall Street investors.

The benefit of the secondary system is that it spreads money around the country so that mortgages are available everywhere at roughly the same cost.

Fannie Mae and Freddie Mac do not buy all mortgage products, instead they only buy conforming loans. Since there's less of a market to sell non-conforming loans such as jumbos, they represent extra risk for lenders. More risk, once again, translates into higher interest costs.

There's More Than One Loan Limit

To this point we've been looking at the loan limit for a single-unit residential property in the lower 48 states. In fact, there are actually many loan limits.

For instance, while the conventional loan limit for a one-unit property is $417,000, if you live in one unit as an owner-occupant you can borrow $533,850 for a duplex, $645,300 for a triplex and $801,950 for a four-plex. In effect, you can use residential real estate financing -- one of the cheapest forms of borrowing available -- to buy investment property as long as you actually live in one of the units. To find out more, mortgage lenders can explain how income from the other units can be used to qualify for financing while tax professionals can explain the write-off strategies associated with such properties.

The loan limits above apply to the lower 48 states. However, conventional loan limits are 50 percent higher in Alaska, Hawaii, Guam, and the U.S. Virgin Islands.

Also, the 2007 conventional loan limit for second mortgages is $208,500 -- 50 percent of the basic single-family cut-off point.

FHA and VA Loan Limits

The FHA loan program uses a complex formula to determine if you're in a "high cost" or "low cost" residential area. If you live in a "high cost" area then the maximum loan amount under the FHA program is equal to 87 percent of the conventional loan limit. Since the conventional loan limit for 2007 is $417,000 in the lower 48 states, this means the largest FHA single-family loan in the continental US would be $362,790. As with conventional loan limits, there are higher limits for owner-occupied properties with two units ($464,449), three units ($561,411) and four units ($697,696). The loan limits for properties located outside the lower 48 states are 50 percent higher.

The FHA program also has a ceiling for "low-cost" areas that's equal to 48 percent of the conventional loan limit or $200,160 for a one-unit property, $256,248 for a duplex, $309,744 for a triplex and $384,936 for a fourplex.

Because FHA loan limits vary by location, it's important to contact qualified lenders before buying a home or refinancing to determine the maximum amount of FHA financing which may be available in your community.

Under the Veterans Benefits Improvement Act of 2004 the VA loan limit is easy to understand -- it's the same as the conventional loan limit. The VA program is open to qualified members of the military and others with certain forms of federal service.

The beauty of the VA program, of course, is that it allows no money down, 100 percent financing.