Will Rising Conforming Mortgage Limits Cause Another Housing Crisis?

Borrowing limits are set to increase. Will that drive buyers to get in over their heads?

Home prices have been on the rise since the start of the year, and they don't appear to be slowing down. A big reason is that low mortgage rates have fueled a surge in buyer demand. Meanwhile, limited inventory is forcing buyers to duke it out in bidding wars, driving property values up.

Not surprisingly, home buyers are increasingly having to take out larger mortgages to finance properties given today's prices. And so come 2022, conforming loan limits will be rising to account for these circumstances.

Conforming loans are those backed by Fannie Mae and Freddie Mac, the two government-sponsored entities that purchase mortgages. It's possible to get a non-conforming loan, but usually, that means getting stuck with a mortgage that's less affordable.

Each year, a limit is set for conforming loans. Right now, that limit is $548,250 in most of the country and $822,375 in high-cost areas. In 2022, these limits are rising to $647,200 and $970,800, respectively. But whether that's a good thing is yet to be determined.

Will rising loan limits cause borrowers to go overboard?

You may remember the housing crisis of 2008 that drove numerous homeowners into foreclosure and caused the real estate market to tank. A big reason that disaster occurred is that too many borrowers took on mortgages they couldn't afford, fell behind, and lost their homes in the process.

Since then, mortgage lenders have gotten stricter about vetting home loan candidates. And they've gotten more conservative in the amount of money they'll lend out. But with conforming loan limits on the rise, the fear is that borrowers will, in the coming year, increasingly get in over their heads.

Thankfully, we're unlikely to experience a housing crisis like we did over a decade ago when the housing bubble burst. Mortgage lenders learned their lesson from those events, and they're likely to continue maintaining stricter requirements for borrowers across the board.

Furthermore, a big reason so many borrowers got into trouble back in 2008 is that they fell underwater on their mortgages -- a scenario that occurs when a home's market value is less than its remaining mortgage balance. When that happens, selling a home to get out of a mortgage that's hard to keep up with isn't an option. And so many homeowners were forced into foreclosure in the absence of being able to fulfill their mortgage obligations.

These days, home values are way up. Even if borrowers take out higher mortgages in the new year, they're less likely to end up underwater, at least not in the near term. Granted, if home values plunge quickly following their current peak, those circumstances might change, and more homeowners may indeed end up underwater in the coming years. But for the most part, that shouldn't happen at nearly the same pace as it did in 2008 since lenders today commonly require higher down payments than they did years back.

Borrowers need to be careful

Of course, borrowers still need to proceed with caution in the coming year in light of higher loan limits. But those who make a 20% down payment will start off with a decent amount of home equity that could, in turn, make it less likely they'll end up underwater. That, combined with tighter lending practices, may be enough to prevent a crisis even as home values decline.