A bill proposing a new way of determining what qualifies as a conforming loan would expand the jumbo market and invite more private capital into mortgage lending — but critics warn it could also push more borrowers into higher-rate loans and worsen an already severe affordability crunch. 

Rising home prices have swelled the number of loans with balances above the conforming loan limits. While those limits rise every year based on the Federal Housing Finance Agency's home price index, the adjustment is static and goes into effect at the start of the year. As a result, at the end of the year, several lenders look to take advantage of the increase in higher balance loans, running promotions where they purchase loans currently above the limit, put them on their balance sheet, to sell to the agencies after Jan. 1.

When FHFA comes out with the new limits, several observers declare they are too high.

But Rep. Scott Fitzgerald, R-Wisconsin has a different concern. A GSE reform bill he is drafting would shift the calculation to an income-based metric, a change he suggested at a Feb. 11 House Financial Services Subcommittee on Housing and Insurance hearing titled "Homeownership and the Role of the Secondary Mortgage Market."

Fitzgerald framed it as a question to Michael Bright, CEO of the Structured Finance Association, suggesting the move would grow the jumbo market and draw in more private capital.

"There's quite a bit of private capital on the sideline looking to get into the mortgage market," Bright said. "The [private-label securitization] market is functioning well, there's more capital to be deployed."

The bill has yet to materialize. A message seeking comment was left with Fitzgerald's office.

That shift, however, would likely come at a cost to borrowers. In a typical mortgage market, conforming rates run lower than jumbo rates.

Is changing the conforming loan calculation a good idea?

Scott Olson, executive director of the Community Home Lenders of America, spent more than 14 years as a staff member on the House Financial Services Committee — including during the drafting of the Housing and Economic Recovery Act, which established the formula for determining conforming loan limits. The conforming loan limits are also the basis for the Federal Housing Administration program's limits.

Olson acknowledged a personal stake in the issue, noting that under prior calculations, certain areas had limits that excluded them from the government and conforming markets.

The CHLA would be concerned that changes to the loan limits could shrink access in very high-cost areas, he said — limits that may appear excessive but often aren't.

"We would tend to argue that the current [method] makes sense because it's based on the bottom line about what you're buying when you're going in and trying to negotiate to buy a home, is what the homes cost in your area," Olson said.

That makes home prices a better proxy for the calculation than using income. Plus, creating an income-based formula adds a level of complexity, he pointed out.

"The formulas were chosen to be based off of real hard data about home prices in the real world, and they get adjusted by home price fluctuations in the real world," Olson said. "The onus hopefully would be on proponents to argue why some other methodology is better."

It's worth noting that the conforming-versus-jumbo rate gap isn't constant. Both the Mortgage Bankers Association and Optimal Blue rate trackers have on several occasions reported an inversion, where jumbo mortgages are priced lower — sometimes for extended periods. Part of the explanation is that banks can offer jumbo mortgages at lower rates to attract customers and deepen other financial relationships.

How a change may hurt consumers

Eric Bernstein, president of broker LendFriend Mortgage, argues that decoupling loan limits from home prices would damage affordability and not just for buyers of high-end properties.

Bernstein gave the example of the Austin, Texas market, where entry-level properties are selling for $400,000 to $500,000.

As an originator, "you want to be able to give somebody options to do 5% down and get into the house, start building equity, and have them as a successful homeowner that's then going to trade up in a few years," Bernstein said.

A change in the calculation could affect those people who need those opportunities and have been working really hard to achieve this goal.

"We need more options, more solutions, to address the affordability crisis that Americans are facing to get into their first home or trade up to their second or third homes," Bernstein said.

Come back tomorrow for part 2 in our 3-part series on jumbo mortgage changes.