Is a Jumbo ARM Right For You?

If you have your sights set on a home in a highly competitive market or a mortgage outside of the conventional loan limits, you may turn to a jumbo loan. Jumbo loans come in various varieties including an adjustable rate mortgage (ARM) – a compelling option for many reasons. In this article, we’ll explore how jumbo ARMs work, as well as jumbo ARM benefits and drawbacks, so you can decide if this mortgage type is right for you.

What is a jumbo loan?

Fannie Mae and Freddie Mac are U.S. government-sponsored organizations that purchase loans from lenders who follow their guidelines to stabilize the U.S. mortgage market. Jumbo loans, also known as non-conforming loans, are loans that exceed the maximum price limits for Fannie Mae and Freddie Mac purchases. The single-unit residence loan limit for most of the country in 2023 is $726,200. This value can vary depending on the city and state in which your potential home resides. Areas like New York, San Francisco, and Hawaii have higher limits.

Since jumbo loans are not backed by any government entity, lenders are at a higher risk and often require a larger down payment and stricter qualification criteria. In return, homebuyers can access more funding to finance their home and may benefit from lower interest rates.

What is an ARM?

An adjustable rate mortgage (ARM) offers an initial fixed interest rate for a certain period, typically ranging from 3 to 10 years, after which the interest rate adjusts periodically based on market conditions. For example, a 10/1 ARM has a fixed rate for 10 years and then adjusts annually.

Many borrowers enjoy the low payments during the initial period and then choose to refinance or sell the property before the rate becomes variable.

How does a jumbo ARM work?

Jumbo loans come in several varieties, including adjustable rates. A jumbo ARM combines the characteristics of jumbo loans and variable rate mortgages. That includes:

• Higher loan amount providing the opportunity to finance larger or more expensive homes
• Stringent jumbo loan requirements including a favorable credit score, DTI, and down payment
• Initial fixed interest rate for a specified period, followed by rate adjustments based on market conditions

Advantages of jumbo ARMs

There are several benefits of ARM loans – specifically jumbo ARMs – ranging from favorable interest rates to home affordability:

• Lower rates – ARM rates can be 1% lower than fixed-rate mortgage rates, resulting in potential monthly savings of $500 or more based on the loan size. Interest rates for jumbo loans are often lower than conforming mortgages due to stricter requirements such as a 20% down payment, higher credit scores, and six-months' worth of cash reserves, which make the loan less risky.
• More buying power – An ARM’s lower initial monthly payment combined with a jumbo loan can help you qualify for a higher cost home, without having to break up the loan into multiple mortgages.
• Unique loan features – Oftentimes, the original lenders will not sell many ARMs like they will with conforming loans. As a result, these mortgages can have guidelines and prices defined by the lender, such as interest-only repayment terms.
• Lower payments – With ARMs, borrowers can take advantage of falling rates without needing to refinance. This saves on new closing costs, and borrowers will see their rates fall automatically.
• Flexible options – The fixed rate period of an ARM can vary, usually from 3 to 10 years, but other terms are possible. Many borrowers choose to take advantage of the low rate during the fixed period and then sell or refinance before the rate becomes variable.

Disadvantages of jumbo ARMs

Because they are non-conforming and higher in value than conventional mortgages, jumbo loan qualifications tend to be stricter than traditional options:

• Higher credit score and down payment – Most lenders require borrowers to have a credit score of over 700 and a jumbo loan minimum down payment of 10% or more. Those with credit scores above 760-780 will get the lowest rates available, saving thousands over the life of the mortgage.
• Lower maximum DTI – The debt-to-income ratio (DTI) is your total monthly debt obligations compared to your monthly income. To qualify for a jumbo loan, a lender will look for a DTI that’s even lower than the 45% DTI required for a conventional mortgage – likely 36% or below.
• Higher financial reserves – Your lender will also want you to prove that you have sufficient funds coming in to pay for the loan plus reserves on hand in case of loss of income. Jumbo mortgage reserve requirements can be up to 12 months’ worth of mortgage payments.
• Second appraisal –  Some lenders may request a second appraisal, adding time and costs to the loan process. Special jumbo loan appraisal requirements help ensure the accuracy of the property's value and minimize risk for the lender.
• Potentially higher rates – Jumbo ARMs often offer lower rates, but some borrowers may receive higher quotes due to the increased risk for lenders. These rates can be one to two percentage points higher than conforming loans. However, refinancing a jumbo ARM is possible once the loan balance falls below the maximum conforming loan limit set by Fannie Mae and Freddie Mac.

The right choice for you

If you have good credit, a DTI of less than 36 percent, and can show consistent employment history, you may be an excellent candidate for a jumbo ARM. 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 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.