Will Higher Conforming Loans & Tax Rebates Prevent Recession?
Treasury Secretary Henry Paulson, along with the House, Senate and White House, has crafted a broad election year economic stimulus package which includes $150 billion in household and business tax breaks, and proposals to up conforming mortgage limits from $417,000 to as much as $729,250. The tax cuts could take a few months, but the conforming loan limit hikes could be in effect mid- to late-February.
On the tax incentives, about $100 billion in tax rebates will go to approximately 117 million families, meaning these households will each receive $854. About $50 billion more in tax breaks will go to businesses.
On conforming loan limits, the amounts will range from $625,000 to $729,250 depending on home price and mortgage debt levels in different U.S. markets. It’s reasonable to expect higher loan limits in markets like California and New York, and lower limits for lower priced areas.
The tax incentives are likely to be more muted than those in 2001, since that was the beginning of the last refinance boom, and consumer spending over the years following those rebates was fueled more by home equity extraction than by one-time tax rebates. As for actual tax cuts (different from rebates), supply-siders argue that tax cuts are what fuel long-term consumer growth by contributing to business investment and job creation. Why then does a recession seem so likely after the recent years of Bush tax cuts?
As for conforming loan hikes, they will only last for one year and will soften the blow that was surely coming with the following three ARM mortgage categories all re-setting in 2008: 2/28 subprime ARMs originated in 2006, 3/27 subprime loans originated in 2005, and 5yr ARMs originated in 2003.
Most of the last category isn’t a threat because 5yr ARMs were primarily taken out by high quality borrowers who made a conscious decision to save 60 months worth of interest versus taking a 30 year loan at the time. For the most part, they’ve now owned their homes for long enough to have equity positions that qualify them for the best refinance options.
The 2/28 loans and 3/27 loans adjust from low interest-only rates to fully-amortized LIBOR+5-7% rates. On a subprime loan of $600,000 that started at 6.25%, that payment of $3125 will go up about $2251 to $5376. With the ability to refinance into a conforming 30yr fixed rate of 5.75%, that payment would only go up $376 to $3501. And the new payment pays principal, whereas the old payment was only paying interest.
So the temporary conforming loan limit increase shouldn’t fuel home prices as some argue. It should help existing homeowners keep their homes. Buyers will have opportunities in this environment, but they need to focus on fair market value. This stimulus may help the market to find a bottom, but buyers shouldn’t try to time the market. They should evaluate market pricing against the amount of time they expect to hold that property.