Order Code RS22172
June 22, 2005
CRS Report for Congress
Received through the CRS Web
Proposed Changes to the Conforming
Loan Limit
Barbara Miles
Specialist in Financial Institutions
Government and Finance Division
Mark Jickling
Specialist in Public Finance
Government and Finance Division
Summary
Two government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, buy
residential mortgages from the original lenders, package them, and sell the resultant
mortgage-backed securities to investors (or hold them in their own portfolios). Current
law includes a conforming loan limit that puts a ceiling on the size of the mortgages that
the GSEs can buy. Securitization of mortgages that exceed the limit – called jumbo
loans – is performed by private financial institutions. GSE status allows Fannie and
Freddie to issue debt at lower cost than other private firms; part of this subsidy is passed
on to home buyers in the form of lower interest rates. Interest rates on jumbo mortgages
are slightly higher than those on the conforming loans that the GSEs can purchase,
although the differential is not constant over time, and reflects other factors besides the
GSE subsidy.
Section 123 of H.R. 1461, the GSE regulatory reform bill, proposes to raise the
conforming loan limit by up to 50% in areas with high housing prices, which would
allow Fannie and Freddie to expand their operations into markets now served by private
(non-GSE) institutions. If the GSEs supplant the existing securitizers of jumbo
mortgage loans, some home buyers in expensive areas may experience a small reduction
in their mortgage rates. Some would argue, however, that (1) the secondary market for
jumbo mortgages works well without GSE participation, and that (2) because the size
of GSE operations already poses a potential risk to financial stability, it would be
imprudent to permit a significant expansion of their activities. This report analyzes the
proposal to raise the conforming loan limit. It will be updated as legislative
developments warrant.
Congressional Research Service ˜ The Library of Congress

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Background
Congress set the conforming loan limit into law with the Housing and Community
Development Act of 1980 (P.L. 96-399). The initial limit was set at $93,750 for a single-
family home (39% above the FHA ceiling at the time), and the law provides for annual
increases in the loan limit to adjust for rising prices (as reflected in a housing price index
published by the Federal Housing Finance Board).1 The loan limit was initially set at a
level significantly higher than the national average home price, and with indexation it has
remained higher. In 2004, the conforming loan limit stood at 116% of the average new
home price, and 139% of the average resale price of an existing home.2 For 2005, the
conforming loan limit is $359,650.
P.L. 96-399 set a higher limit for mortgages on residences in Alaska, Hawaii, and
Guam, all thought at the time to have higher than normal costs of building and lower than
normal access to credit because of their remoteness. In those areas, the conforming loan
limit was set at 150% of the limit that applied to the rest of the nation. In 1992, the Virgin
Islands was added to the list of areas where the 150% limit applied.3 In 2005, the limit
for these four states and territories is $539,475.
How H.R. 1461 Would Raise the Loan Limits
Section 123 of H.R. 1461 (as reported by the House Financial Services Committee)
would abandon the single conforming loan limit for the contiguous 48 states. The loan
limit would be allowed to rise in metropolitan statistical areas that met the definition of
“high-cost.” A high-cost area would be one where the median home sale price exceeded
the current conforming loan limit. That median home price would become the
conforming loan limit for that metropolitan area. Increases would be capped at 150% of
the statutory loan limit – the same limit that now applies to Alaska, Hawaii, and the two
island territories.
A look at median prices in various metropolitan areas of the country shows that the
conforming limit would rise in several places. The available data are for existing single-
family home prices, collected by the National Association of Realtors, covering 134
metropolitan areas. Based on data for the first quarter of 2005, the limit would rise in 12
of the 134 areas, mainly in California and the New York City area. The 12 areas and the
extent of the increase are shown in Table 1 below.
This picture probably understates the number of areas where the conforming loan
limit would rise (if H.R. 1461 were enacted in its current form), for at least two reasons.
First, the data in Table 1 reflect median prices for existing homes, while the medians for
new homes are generally higher, and the designation of “high-cost area” would be based
on the median of all prices in an area.
1 Higher limits were set for home mortgages covering 2-, 3- and 4-unit dwellings. See 12 U.S.C.
1454 for Freddie Mac and 12 U.S.C. 1717 for Fannie Mae.
2 The 2005 Mortgage Market Statistical Annual, Bethesda, MD, Inside Mortgage Finance
Publications, 2005, v. 1, p. 185.
3 By Sec. 1382(k) of P.L. 102-550.

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Second, the list of high-cost areas reflects only first quarter price data, while annual
adjustments to the limit are based on October-to-October price changes. Thus, by the
fourth quarter of 2005, the number of high-cost areas may well increase; median prices
in at least three metropolitan areas fell only about 10% short of the national threshold in
the first quarter.
Table 1. Metropolitan Areas Where the Conforming Loan Limit
Would Rise Under H.R. 1461
Metropolitan Area
Median price as % of limit
New limit
Anaheim/Santa Ana (Orange County),
183% $539,450*
CA
Boston, MA
111%
$398,300
Los Angeles, CA
132%
$474,700
New York/N. New Jersey/Long Island,
121%
$435,200
NY/NJ/CN
Bergen/Passaic, NJ
125%
$448,100
Middlesex/Somerset/Hunterdon, NJ
106%
$381,400
Nassau/Suffolk, NY
124%
$446,700
Newark, NJ
106%
$379,700
San Diego, CA
162%
$539,450*
San Francisco Bay Area, CA
192%
$539,450*
Washington, DC/MD/VA
103%
$369,000
West Palm Beach/Boca Raton/Delray
101%
$362,800
Beach, FL
* mortgage amounts are rounded to the next lower $50
Source: National Association of Realtors.
The Impact of Raising the Conforming Loan Limit
The data in Table 1 suggest the regional variation in housing prices: nationally, the
conforming loan limit exceeds the average house price, but in these high-cost areas, the
median home price is higher than the limit. GSE status allows Fannie and Freddie to
borrow at lower interest rates than non-GSE financial institutions.4 A portion of this
subsidy is passed on to home buyers whose mortgage loans are purchased and securitized
by the GSEs. The existence of high-cost housing areas implies that the benefits of that
subsidy are not distributed uniformly. In 2003, Fannie and Freddie purchased 35.1% of
all mortgages (by dollar value) originated nationwide. This percentage varied from state
to state. In three states and the District of Columbia, the GSEs purchased less than 30%
of new mortgages, and all three states (and the District) appear in table 1 – California,
4 The chief financial advantage conveyed to Fannie and Freddie by GSE status is the “implicit
guarantee.” Although GSE debt is not explicitly backed by the full faith and credit of the
Treasury, market participants believe that the government will not allow either GSE to become
insolvent. Thus, GSE debt is perceived as less risky than debt issued by other firms with similar
balance sheets, and investors will accept a lower interest rate. This funding advantage is
effectively a subsidy, although no expenditure of taxpayer funds is involved.

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New York, and Connecticut. In 15 states, on the other hand, the two GSEs purchased
over 40% of new mortgages.5
In high-cost areas, in other words, the GSEs’ mortgage purchase and securitization
operations are constrained by the conforming loan limit. Loans that exceed the
conforming loan limits can only be securitized by non-GSE issuers, and there is a large
secondary market for jumbo mortgage loans. In 2004, total jumbo loan originations were
estimated at $548 billion, while $233 billion in jumbo MBS were issued, implying a
securitization rate for jumbo mortgages of 42.6%.6 By contrast, Fannie and Freddie
securitized 80.2% of loans originated in 2004 in the conventional, conforming mortgage
markets where they are allowed to operate.7
In contrast to the secondary market for conforming loans, where the GSEs are
completely dominant, dozens of issuers are active in the jumbo market. The top five
issuers accounted for only 42.4% of the market in 2004.8
Conforming mortgage loans tend to carry lower interest rates than nonconforming
loans. A number of studies have attempted to measure the spread between conforming
mortgage and jumbo loan rates and the extent to which the rate differential can be
attributed to the subsidy contained in GSE status.9 Most estimates of the spread between
conforming and jumbo loans fall into the range of 18-25 basis points. (A basis point is
1/100th of a percent.) All researchers assume that at least part of this spread is due to the
GSE subsidy, but other factors are involved. For example, as properties become more
expensive, lenders worry more about price volatility. That is, as the risk of a significant
drop in the market value of the house – the loan’s collateral – increases, lenders raise
rates to compensate for that risk.10 Second, the existing jumbo secondary market cannot
realize certain economies of scale because market participants are generally frozen out of
the conforming loan market (due to their inability to compete with the funding advantages
of the GSEs). These and other factors suggest that allowing the GSEs into the jumbo
5 The 2005 Mortgage Market Statistical Annual, v. 1, p. 25.
6 ibid., v. 2, p. 6.
7 ibid. In addition to the jumbo market, there is a very large subprime mortgage market where
GSE securitization is restricted.
8 ibid., v. 2, p. 25. (The top five jumbo MBS issuers are Countrywide Financial, Bear Stearns,
Lehman Brothers, Bank of America, and Wells Fargo.)
9 See U.S. Congressional Budget Office, Updated Estimates of the Subsidies to the Housing
GSEs, Apr. 8, 2004; Wayne Passmore, Shane Sherlund, and Gillian Burgess, “The Effect of
Government Sponsored Enterprises on Mortgage Rates,” Real Estate Economics, forthcoming
(2005); Wayne Passmore, Roger Sparks, and Jamie Ingpen, “GSEs, Mortgage Rates, and the
Long-Run Effects of Mortgage Securitization,” Journal of Real Estate Finance and Economics,
v. 25, Sep.-Dec. 2002, p. 215; Joseph A. McKenzie, :A Reconsideration of the Jumbo/Non-
Jumbo Mortgage Rate Differential,” Journal of Real Estate Finance and Economics, v. 25, Sep.-
Dec. 2002, p. 197; and Brent Ambrose, Michael LaCour-Little, and Anthony Sanders, “The
Effect of Conforming Loan Status on Mortgage Yield Spreads: A Loan Level Analysis,” Real
Estate Economics, v. 32, Winter 2004, p. 541.
10 The issue of volatility is particularly important in areas where many observers believe that
home prices are artificially high due to a speculative bubble.

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market would not cause the entire spread to disappear. There is no consensus as to how
much of the 18-25 basis point spread is due to the GSE subsidy – estimates range as low
as seven basis points.11
Thus, it is uncertain how much benefit homebuyers would receive if the conforming
loan limit were increased according to H.R. 1461. An upper bound estimate may be
obtained by assuming that the interest rate on a 30-year, 6.25% mortgage of $539,45012
is reduced to 6%. The home buyer’s monthly mortgage payment of $3,324 (at 6.25%)
would be reduced by about $87. Over 30 years, this reduction yields interest savings of
about $31,000. Of course, this projected saving shrinks if one assumes that some portion
of the rate spread will persist. If the interest rate paid by the hypothetical home buyer in
the example above falls by only seven basis points, the monthly payments are lower by
about $25 a month, and interest savings are about $9,000 over 30 years.
It should also be remembered that under H.R. 1461 not all mortgages in high-cost
areas would become conforming loans. Loans for amounts greater than the area median
house price (capped at 150% of the statutory limit) would still be treated as
nonconforming. In other words, the very top end of the housing market would be
unaffected by the bill’s provisions.
Policy Issues
The case for raising the conforming loan limit, as H.R. 1461 would do, is based on
equity concerns. Home buyers in the conforming mortgage market receive part of the
GSE subsidy in the form of lower interest rates. Since housing prices vary across the
nation, the geographical distribution of this benefit is uneven. The current loan limit is
$359,650; in many parts of the country, this amount covers all but the top end of the
housing market. In high cost areas like San Francisco or New York City, on the other
hand, a large proportion of real estate transactions take place over that limit. Since
current law sets a higher limit for Alaska, Hawaii, Guam, and the Virgin Islands, where
housing costs are assumed to be high, why not raise the limit in other areas where prices
are measurably higher?
A counter-argument is that the additional subsidy created by raising the loan limit
would go overwhelmingly to mortgage holders with high incomes. If the purpose of the
GSEs is to foster home ownership, the impact of raising the limit is likely to be minor:
those who would benefit from the change already have high homeownership rates.
Arguments in favor of retaining the current limit are based on other concerns as well.
First, there are questions involving Congress’s rationale for creating the GSEs in the first
place. The GSEs were intended to foster and develop a secondary market for home
mortgages. That market is now well-established and does not depend on the GSEs for its
continuance, despite their dominance in the parts of the housing market where they are
allowed to operate. Raising the loan limit would not result in the creation of a new
secondary market; it would simply allow Fannie and Freddie to expand their business at
11 See Passmore, Sherlund, and Burgess, op. cit.
12 Mortgages are in multiples of $50; thus, the limit is rounded to the next lower $50.

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the expense of the numerous private (non-GSE) firms that now make up a competitive
market.
Second, there are macroeconomic objections to increasing the government subsidy
to the residential mortgage market. Any policy that directs investment to a favored sector
incurs a cost: investment funds for other uses become more scarce or expensive. There
is some concern – not shared by all observers – that a bubble in housing prices may be
distorting investment patterns and could slow economic growth if it bursts. To the extent
that a higher conforming loan limit made mortgages cheaper in the jumbo market, it
would put even more upward pressure on home prices in those markets where evidence
of a bubble is clearest. Of course, given the many federal programs and policies that
subsidize housing, the increase in the GSE subsidy implied by a partial takeover of the
jumbo market by Fannie and Freddie is not likely to bring about a major shift in
investment.
The loan limit proposal raises basic economic questions about the role of GSEs.
Subsidizing mortgages through GSE status creates a distortion in the market outcome.
The conforming loan limit places another distortion on top of the first, by driving a wedge
between market outcomes in the conforming and nonconforming markets. Raising the
conforming limit reduces the second distortion but increases the size of the first
distortion.13 If one believes that the first distortion is socially desirable, then reducing the
second is also desirable. However, if the first distortion – the basic GSE subsidy – is
undesirable (or desirable only at the low end of the market), then reducing the second
distortion (and thereby expanding the first) is economically inefficient.

Finally, there is the issue of systemic risk posed by the rapid growth of the GSEs in
recent years. Financial trouble in either GSE could spill over into the many institutions
that hold large quantities of GSE debt (as well as into the mortgage market). The
consequences of such a crisis are unpredictable, but they include the possibility of a costly
bailout by the taxpayers. As the scale of GSE operations expands, the potential for
systemic disruption also increases.
In this context, Federal Reserve Chairman Alan Greenspan has often advocated a
reduction in the size of the GSEs’ investment portfolios. H.R. 1461 recognizes this
concern by stipulating that the higher loan limit will apply only to mortgages that the
GSEs securitize and sell, rather than hold in their own portfolios. However, it is not clear
that this provision will prevent the GSEs from increasing their portfolios if they choose
to do so: at the end of 2003, Fannie Mae held $31 billion in Freddie Mac securities, while
Freddie held $75 billion in Fannie Mae obligations.14 The language of H.R. 1461 appears
to permit either GSE to hold in portfolio jumbo mortgage-backed bonds issued by the
other.
13 That is, as the scope of GSE activities is allowed to expand, the amount of the subsidy to home
mortgage markets expands automatically.
14 The 2005 Mortgage Market Statistical Annual, v. 2, p. 129.

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