Can I Afford a Jumbo Loan?

If you are looking for a new home and have heard you might need to use a jumbo loan, you might be a bit worried. Although jumbo loan sounds really big and scary, it does not have to be. This article intends to explain the ins and outs of jumbo loans and give some ideas on how you can lower your payments.

Jumbo Loan Basics

Jumbo loans are also called nonconforming loans. They are considered jumbo because they don’t conform to the maximum loan limits of Fannie Mae and Freddie Mac. These are two publicly traded, government-sponsored enterprises that will buy loans up to certain price limits. The limits are set every year, and in 2023, for the majority of the country, the maximum loan limit is $726,200. There are several locations that have higher limits.

Many areas have housing priced above the local conforming loan limits — these are jumbo loans. Because they are nonconforming loans, they can be a little bit different.

Jumbo Loan Differences

Because jumbo loans are not purchased by Fannie Mae and Freddie Mac, and because they are of higher value, banks and other lenders consider them riskier. This increased risk can mean a few different things. You will find that the rates for a jumbo loan will often be higher than the rates for a conforming loan. A higher rate means the monthly mortgage payment will be higher per thousand dollars borrowed over a conforming loan.

One particular benefit of a jumbo loan is that there are fewer restrictions on property types. You can use a jumbo loan to finance primary residences, investment properties and even vacation homes.

Additionally, the requirements for a jumbo loan will generally be more stringent than the requirements for a conforming loan. Lenders’ requirements can vary greatly because they are not restricted to the conforming guidelines set by Fannie Mae and Freddie Mac and they set their own underwriting requirements. Here is a brief list of what lenders look for when obtaining a jumbo loan:

• Typically, a 20% down payment is required. However, down payments can range from 15-30% (some as low as 5%). If you want to reduce ongoing costs, a 20% down payment means you won’t need to pay private mortgage insurance. For example, a monthly PMI payment on a $1 million jumbo loan with a 90% loan-to-value ratio for a borrower who has a credit score in the mid-600s could be about $500 or more.
• The monthly mortgage payment should be less than 38% of your pretax income. And your debt-to-income ratio should be 43% or less. Many lenders require a maximum DTI of 36%.
• You should have a minimum credit score of 680, but many lenders will look for 700 or more (the higher it is, the better the rate you can obtain).
• You will be required to provide key financial documents, such as:
  o    Proof of income.
  o    Proof of liquid assets. You may need a full year’s cash reserve to qualify. This means you will need 12 mortgage payments’ worth of savings in your bank account after the down payment and closing costs. Six months of reserve requirements are also common.
  o    Proof of ownership of nonliquid assets.
  

Why a Jumbo 5/1 ARM Could Be a Great Choice

Adjustable-rate mortgages have been out of fashion for a while because they became notorious during the housing crisis of 2008 and rates for the past few years have been historically low. Now that rates are beginning to climb again, ARMs are becoming more popular.A 5/6 or 5/6m ARM will have an adjustment every six months after year five. An ARM has a fixed-rate period followed by a floating period. A 5/1 ARM has a fixed rate for the first five years of the loan. Then from year six on, the rate will adjust up or down yearly with market conditions. ARMs are great because they can save you a lot of money every month.

When comparing a 30-year fixed-rate jumbo loan to a 30-year ARM, the initial rate for an ARM will likely be lower than the rate for the fixed-rate loan. This difference can mean significant cost savings for you every month.  However, depending on future rates and the term of your loan, and ARM could end up with a higher rate somewhere down the road.

Let’s look at an example to see the difference this makes.

• Let’s say we have a 30-year fixed-rate jumbo mortgage that has a rate of 4.56% while a 5/1 jumbo ARM has a fixed-rate period of 3.73%.
• Assuming a $750,000 loan, the fixed-rate mortgage will pay principal and interest of $3,832 monthly. The ARM borrower will pay $3,469.
• This is a difference of about $363 a month and $4,355 a year. It is like making one less payment per year by choosing the ARM.
  

ARMs Are Great for Those Who Will Move

The other reason that ARMs are a good choice for specific buyers is if you are confident that you will be moving before or just after the fixed-rate period ends. The majority of Americans will move within seven years of purchasing a home. Data from iPropertyManagement shows that for homes sold in the last quarter of 2021, the average length of ownership was 6.3 years. Although in the past, for all homeowners, most have been in their homes for an average of 16 years. Unsurprisingly, the data shows that younger buyers are more likely to move than older buyers.

If you know that you will move within the fixed-rate period of an ARM, you can benefit from the lower rate you will receive during the fixed-rate period over a 30-year fixed-rate jumbo loan.

Can You Afford the Jumbo Loan?

If you have a 20% down payment and a 12-month supply of cash, your credit score is over 700, the mortgage is less than 38% of your pretax income, your DTI is below 36% and you can show proof of all of these, then according to most mortgage companies, you can afford the jumbo loan. This means you have a good chance of approval. Everyone’s circumstances are different, and you will want to discuss your situation with a loan professional who can help you in making the correct decision.

A jumbo loan is a big step, so it’s important to decide if a higher priced home or luxury property fits into your budget.