Declining home values in 2006 may reduce the size of loans eligible for purchase by Fannie Mae and Freddie Mac, thereby impacting consumer loan costs in the higher priced housing regions in the country. Fannie Mae and Freddy Mac are the federal agencies that purchase most of the conventional loans issued today, thereby allowing the lender to turn around and make another loan.

The so-called "conforming" loan limit is based on the Federal Housing Finance Board's Monthly Interest Rate Survey, which includes an analysis of average home prices. According to the latest version released, home prices have declined 3.1 percent in the 12 months through September. The limit for 2007 will be calculated upon release of October data on Nov. 28.

These agencies put money into circulation that makes it possible for lending institutions to service all segments of the market. They do so by packaging the mortgages they buy and reselling them to investors. A smaller limit may match a broad decline in loan sizes, but disadvantage the companies in areas where prices remain above the 2006 limit of $417,000.

If the loan limit drops significantly, the loans that fall within their purview will be irrelevant in the higher priced markets. The median price of a home in the San Francisco Bay Area was over three quarters of a million dollars in June of 2006. In some counties within the metro area, the median was higher than that. In Santa Barbara, California the median home price has reached one million dollars. These are extremes, but even in the northern New Jersey-New York area the median home price was almost $475,000.

Loans within the conforming limit cost borrowers up to 0.5 percentage point less than a non-conforming “jumbo” loan. If the limit is cut, the former cap figure of $417,000 would cost an additional $100 dollars per month as a non-conforming loan.

Some analysts believe that it is possible the loan limit will remain static while home prices in the most highly inflated areas come down. But since the soft market essentially spans all housing sectors, it is likely that the limit will be reduced at the end of November according to analysts.

During the home buying mania of 2000-2005, the cost of money seemed to be secondary to getting into the home. Many buyers saw home ownership as the most lucrative form of investment available to them, and were willing to live with adjustable rate mortgages that carried very expensive premium payments if they lived beyond the initial low interest rate. Now that refinancing out of these ARMs is much more difficult in a stagnant housing market, buyers are going to have to use new guidelines to evaluate their potential purchases.

Lenders will also, presumably, be going through some adjustments. Competition for new mortgages will be higher and conforming loans will be less readily available in those markets where housing prices are still healthy. It may also be time for lenders and brokers to take a little closer look at their fee structures, and for consumers to demand that they be a little more transparent on just what the fee structures are and how much cash is flowing to the bottom line for both broker and lender.