SANTA CRUZ (November 25, 2007) - In response to my column last week regarding conforming loans, a reader writes: “perhaps you might suggest to potential sellers that they lower the prices of their homes so that buyers could qualify under the Fannie Mae loan limits; after all, the majority of the homes that are selling, aside from the high-end properties, are the homes priced under $600,000.”

While I don’t believe that sellers give a hoot about whether the buyers of their homes can qualify for a conforming loan or not, the point deserves some consideration. I believe the topic is best discussed from the standpoint of what the prospective homebuyer can afford and that discussion really must start with a consultation with a mortgage professional.

In the first place, a conforming loan used to purchase a single family home, condo or townhome is a loan that is at or less than $417,000 and is underwritten to Fannie Mae or Freddie Mac guidelines, which are more lenient than the underwriting guidelines for jumbo loans (loan amounts over $417,000). Secondly, the interest rates for a 30 year fixed rate are significantly lower for conforming loans; they are up to 0.75 percent lower. For a $417,000 mortgage that difference is $205 per month. If California ever gets the special treatment that Alaska and Hawaii have, the conforming limit would increase to $625,500 and the savings would grow to $307 per month. By the way, Governor Schwarzenegger has written a letter strongly urging the leaders in the U.S. Senate and the House of Representatives to support the higher conforming loan limit in California.

The other tool that we can use to enhance the usefulness of conforming loans is to combine a conforming loan with a 2nd mortgage. Although the interest rates on 2nd mortgages are about 2.5 percent higher than on first mortgages, the loan amounts on 2nd mortgages are smaller than the 1st mortgages which gives the borrower a ‘blended’ rate that is often lower than the alternatively priced jumbo rate. What’s truly unique here is that the 2nd mortgage is underwritten to the same standards as the 1st mortgage, it is a 30 year fixed rate and can go up to $350,000. This conforming combination will allow a buyer to buy a home priced up to $807,000 with 5 percent down. Both the 1st mortgage and the 2nd mortgage have the option (which costs extra) to pay just the interest portion of the mortgage for the first 10 years.

For example, to purchase a home for $600,000 with 20 percent down, the buyer would need to borrow $480,000. One way to accomplish that is to obtain a 1st mortgage for $417,000 and a second mortgage for $63,000. At a 30 year fixed rate (with no prepayment penalty!) of 6 percent for the 1st mortgage and 8.5 percent for the 2nd mortgage, the blended rate is 6.33 percent, which beats the jumbo 30 year fixed rate.

Additionally, the guidelines for conforming loans allow the borrower to spend up to 65 percent of his gross income on his house payment. To purchase the $600,000 home in the example above, the Principal, Interest, Taxes and Insurance (PITI) would be $3684 and the minimum income required to qualify for this debt load would be $68,000/year. Alternatively, jumbo investors typically do not allow a borrower to spend more than 50 percent of their income on PITI. Even at a rate of 6.5 percent, the PITI would be $3729 and the minimum income required would be $89,500 in order to qualify for the jumbo loan.

Clearly, the best choice is to go with the conforming 1st mortgage in combination with a 2nd mortgage. Make sure that your mortgage professional adequately explains the pros and cons of each financing option so you can make an educated and informed decision. Caution: not all lenders offer this unique conforming 1st and 2nd combination!

This column is written every Sunday by Peter Boutell, Certified Mortgage Planner and a principal at Santa Cruz Home Finance. You may reach him at (831) 425-1250 or email him at Peter@SantaCruzHomeFinance.com.