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After much anticipation, the US Department of Housing & Urban Development (HUD) finally announced the new conforming and FHA loan limits.  The Washington DC metro area will have a loan limit of $729,750 and the Baltimore area will have a limit of $560,000.  These new limits apply to both conforming and FHA loans (previously the conforming limit was $417,000 and the FHA limit was $362,790).  Most attention will be given to the fact that many loans that were previously "jumbos" will now be conforming -- which means they will now have an interest rate that is dramatically lower (currently over 1% lower).  But this expanded availability of lower rates, in my opinion, is not the primary benefit of HUD's much needed action.

More important is that down payment requirements and other underwriting standards are much more lenient on conforming and FHA loans.  As an example, the down payment required on an FHA loan can be as little as 3% -- as compared to "jumbos" that now often require at least 10% down.  Lower down payment requirements will provide a huge shot in the arm to our real estate market, where entry level homes in some sub-markets easily exceeded the previous conforming and FHA limits.  At Sawbuck, we know first hand that our region has an extremely high number of young professionals with great income and credit -- but who understandably have not yet saved enough money to buy a home under current "jumbo" guidelines.  HUD's new loan limits are a welcome change for these folks, not to mention home sellers who for the first time in many months could start seeing more prospective buyers coming through their homes.

When the US House of Representatives passed the “stimulus package” a few weeks back, most reports focused on the $300-1200 tax rebates that Americans would get in their mailboxes later in the year. At the time, an important piece of the legislation went under-reported. The bill proposed to raise the conforming limit--the maximum loan size Fannie Mae or Freddie Mac can buy--from $417,000 to $729,750.

In the weeks since, especially among those in the real estate industry, word of this change began to spread; it became more widely reported in the media as well. But the specifics of the bill were not well-presented. The change would raise the new limit to no more than 125% of the median price in certain “high-cost” areas, with a maximum of $729,750.

In fact, the Senate just yesterday approved a bill with the same provision. It was quickly approved by the House and is expected to be signed into law by the President quickly.

The HUD Secretary is to determine within 30 days what the median home prices (and therefore new conforming loan limits) are for each “area”. The only wildcard is: how will he define an “area?” The most likely answer is by MSA; median home price data by MSA is readily available and well-known.

Here’s the problem, and the thing most commentators missed in the initial excitement about the new limit: very few places in the country would enjoy the new $729,750 maximum. Because many MSAs are very broadly defined--they include many outlying counties far beyond the city core--their median home prices are surprisingly low.

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After three days of fielding press and industry-insider interviews, I have a new perspective on people's knee-jerk reaction to what we are doing. Now, keep in mind that these are, by definition, the most jaded and cynical questioners with regard to new business models in the real estate arena. They know all the ways people have tried to skin the cat, and they assume we fit into one of the pigeonholes they've created.

The greatest skepticism was reserved for our Free Mortgage. The assumption is that this is done with smoke and mirrors. Partly, this is due to the way traditional brokers have used ABA and in-house mortgage companies to abuse their customers--making extra money from them in the name of "one-stop shopping". So there is a tradition in the industry of using mortgage as a sneaky way to make money and pad the bottom line.

Second, mortgage is such an easy thing to play numbers games with. It's like a balloon--squeeze on the rate and the points increase; squeeze on the points and the "fees" increase. Anyone can offer a "no closing cost" loan (if you don't care about the rate). Anyone can offer a super-low rate (if you don't care about points and fees).

So, I wanted to address this issue directly: What makes our Free Mortgage legit? How can our buyers really get a well-below-market rate AND pay no closing costs?

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Strange as it may sound, in recent years, large real estate brokers make less and less of their money from real estate. To compete for agents, they've had to gradually increase the "split"—the percentage of the commission that stays with the agent. Agents keep more; brokers keep less.

To compensate for this lost revenue, these brokers have turned to "ancillary services" (i.e. mortgage, settlement, insurance, etc.) to pump their profits back up. Many brokers now make more on these other services than on real estate itself.

Because these "ancillary services" are so important to the bottom line, agents are pressured in subtle (and not-so-subtle) ways to direct their customers to the in-house mortgage company. Needless to say, the in-house loan officer feels little need to be aggressive in quoting rate, points and fees. They know most of these customers are "in the bag" due to the trusted agent's recommendation—they aren't going to shop.

For these large brokers, real estate is becoming a loss leader designed to sign up as many buyers as possible, who in turn feed their mortgage and title profit centers.

All mortgage companies (mortgage brokers, retail lenders, in-house mortgage operations, etc.) make money in pretty much the same way. Every day, they get wholesale rates in the back door, based on what investors (pension funds, endowments, hedge funds, etc.) are willing to pay for new mortgages. Out the front door come the retail rates borrowers actually pay.

The difference—call it a markup—covers their overhead (rent, salaries, advertising, etc.), plus the company's profit and the loan officer's commission.

The trick is that the "markup" comes in three forms: fees, points and a higher rate.

• Fees: Mortgage companies usually charge buyers a thousand dollars or more in fees, including "application fees", "underwriting fees", "processing fees", "admin fees" and "funding fees".
• Points: Sometimes called an "origination fee", points are calculated as a percentage of the loan amount. One point equals one percent of the loan. So on a $400,000 loan, a half-point origination fee (0.50) would be $2,000.
• Higher Rate: Investors are willing to pay mortgage companies extra for the same loan with a higher rate. For example, investors might pay nothing for a loan at 6%; but for the same loan at 6.375%, they might pay the mortgage company $4,000.

Mortgage companies are free to use whichever combination they want in order to attract customers, but still make money. Some market low rates (like those who advertise in online or newspaper rate charts), but make it up with fees and points. Others market low or no fees (Bank of America comes to mind), but charge higher rates. You'll pay in one way or another, because mortgage companies have to make money.

But it is in every mortgage company's interest to make a true apples-to-apples comparison difficult. Otherwise it would drive margins down to nothing. In the end, they are all selling the same product, and it is hard to keep it from becoming completely commoditized.