NewBuyer Weblog

Conforming Loan Limits – Who Sets Those Anyway?

Posted by Elizabeth Dennis on January 31, 2010 | No Comments

In a prior post, we talked about how FHA loans differ from conventional loans.  One of the areas of comparison we looked at was the “maximum purchase price.”  Let us take a look at how that maximum amount is determined and a major benefit of setting standards.

Who Sets the Limits?

Fannie Mae and Freddie Mac are responsible for setting the loan limits on conventional loans.  Fannie Mae (The Federal National Mortgage Association – FNMA) and Freddie Mac (The Federal Home Loan Mortgage Corporation – FHLMC) do not provide loans directly to you; but act as “secondary lenders” which means they lend to the institutions that lend to you.

How and When are the Limits Set?

The calculation Fannie Mae and Freddie Mac uses to calculate loan limits is quite simple really.  The limits are set every October.  Fannie and Freddie first determine how much the average home price increased during the prior year.  They take a look at the current average home price and compare it to the average home price from the prior October.  A percentage increase is calculated with these two numbers.

For example:  If the average price of homes in the United States is $150,000 in October and one year later the average home price jumps to $165,000 – we know the average home price has increased by 10%.

The following year’s loan limit will simply be the current year’s amount increased by that same percentage increase we saw in the average home prices.   In our example, the following year’s limit will be ($165,000 + $16,500) or $181,500.

What are the Benefits of Conforming Loans?

When a loan follows (or “conforms”) to the guidelines set by Fannie Mae and Freddie Mac, it becomes a conforming loan.  When loans are underwritten to the same standards, lenders end up selling essentially the same loan (with perhaps a slight variation).  In Economics 101 we learned as more and more people sell the same thing; prices for that product eventually go down.  In our case, standardizing loans translates into lower rates for borrowers.