Updated December 15, 2022
Homebuyers in the market for more expensive homes and those in highly competitive markets, like the one we are in currently, will often have to turn to loans that are a bit different from the conventional (conforming) 20% down, 30-year fixed-rate mortgages that are the most common. In these cases, the jumbo loan is turned to for financing. Jumbo loans have a few features that set them apart from other types of mortgages.
These features include both advantages as well as drawbacks, so it is vital for a homebuyer who is considering a jumbo loan to understand what is involved in this type of financing. This way they can make an informed decision as to whether or not a jumbo loan is right for them or if they're better off adjusting their buying strategy and finding another financing option.
What Is a Jumbo Loan?
Jumbo loans are also called nonconforming loans, and they are loans that are too large (hence jumbo) to conform to the rules that are laid out by the main mortgage insurers, Fannie Mae and Freddie Mac.
The majority of the attributes of jumbo loans and conforming loans is similar. Both of these loans require borrowers to meet defined eligibility requirements that include a minimum credit score, minimum income thresholds, ability to repay and minimum down payment amounts. Both of these mortgages are issued and underwritten by private lenders who offer competitive rates and terms — not by the government. Many jumbo loans also adhere to the qualified mortgage guidelines, like prohibiting excess fees or loan terms or negative amortization, which are set by the Consumer Financial Protection Bureau.
The main difference begins with the limits that define the line between conforming and jumbo loans, which vary throughout the country. In 2023, for most counties nationwide, the limit for single-family conforming loans is $726,200. However, in markets that are classified as high-cost areas (mainly in the Northeast and West Coast), the limit for conforming loans is increased to $1,089,300, with a few exceptions that are even higher.
Jumbo loans are generally used for purchasing a high-priced luxury property. However, with the run-up in prices we have seen through the pandemic, and the historic low rates that are helping buyers purchase but pushing average prices up, home prices in many competitive areas are already in the territory of jumbo loans.
How Does a Jumbo ARM Work?
Just like traditional mortgages, jumbo loans have several options available for borrowers. Jumbo loans can be fixed-rate or adjustable-rate mortgages. Most jumbo loans will have terms for 30 years, but 15- and 20-year jumbo loans are also available.
Because jumbo loans are not guaranteed by Fannie Mae or Freddie Mac (they don't conform to the maximum limits), the lender is not protected by the government from any losses if the borrower defaults. Therefore, nonconforming mortgages are considered riskier by the lender, and this means the criteria needed to qualify for a nonconforming loan are more stringent than what you would generally find for a conforming loan.
Fixed-rate mortgage: The annual rate of interest does not change for the loan’s entire life. Adjustable-rate mortgage: The loan will start with a fixed rate, which is usually lower than a current fixed-rate mortgage. After a defined period, usually between three and 10 years, the rate will adjust up or down every six months or per year for the rest of the loan’s life.
Buying a Higher-Priced Property
If you are looking at a higher-priced property, whether it is in a hot market or it is a traditional luxury property, you will need to consider a jumbo loan. This means there will be more stringent credit requirements for you to secure it (every lender has its own requirements). There are other minimum requirements you must meet that include the following:
- Proof of income. You will need to supply two years' worth of tax documents that show you have a constant and reliable source of income. Lenders also like to see that you have sufficient liquid assets available to cover six months of mortgage payments, though more is preferable.
- Credit history and score. The higher your credit score, the better. The number of lenders that will approve a jumbo loan with a credit score below 700 is slim. As your credit score increases, your rates will go down. Those with credit scores above 760-780 will get the lowest rates available, saving thousands over the life of the mortgage.
- Debt-to-income ratio. This ratio (a borrower's total monthly debt obligations compared to their monthly income) should not exceed 45% in order to qualify for a conventional mortgage. For a jumbo loan, a mortgage company will be looking for a DTI that is at the high end (43%) and will ideally be at 36% or below.
Taking Advantage of Lower Rates
Interestingly, when borrowers go searching for jumbo loans, they may find the rates are lower than conforming loans. There are a few reasons behind this, including:
- Stricter qualifications. What it takes to qualify for a jumbo loan is more stringent. Therefore, the risk for the lender is lower, making the competition for these fiercer.
- Banks have fewer fees. Because these loans are not sold to Fannie Mae or Freddie Mac, the payment and qualifying rules are more flexible. The guarantee fees that Fannie Mae and Freddie Mac charge, which ensure against default, are not charged. These savings are passed onto the borrower.
- Properties have more value. Jumbo loan properties are considered better collateral if the loan defaults. Additionally, customers who qualify for jumbo loans will usually make a down payment of 20% and have additional funds to pay for a portion of the property (the six-months’ reserve mentioned above). This all provides the lender with built-in equity on a luxury home compared to a less expensive home that had a 3-5% down payment.
Why a Jumbo ARM Could Get You – Your Dream Home
If you have good credit, have a DTI of less than 36% and can show consistent employment history, you are indeed an excellent candidate for a jumbo loan. If you have a dream home that exceeds the conforming home limits, a jumbo loan may be exactly what you need to purchase it. For other borrowers who are close to these qualification levels, you may also qualify, but your terms may not be as favorable.
There is definitely a need for jumbo loans, especially in today’s home buying environment. And there’s no better place to start shopping than at a credit union.
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