Pros and Cons of Jumbo Loans

Homebuyers looking for additional money to buy a new place may need to consider 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, otherwise known as nonconforming loans, are loans that exceed the maximum price limits for Fannie Mae and Freddie Mac purchases.

For 2023, their single-unit residence loan limit for most of the country is $726,200. This value can vary depending on the city and state in which your potential home resides.

We have assembled the following information about jumbo loans, including pros and cons, to help you decide if a jumbo loan is the right option for you. 

Jumbo Loan Basics

While $726,200 is the conforming limit for much of the country, there are several locations where the values are higher. These are in expensive areas like New York, San Francisco and Hawaii, where million-dollar homes are more commonplace. Even still, the average home prices in many places around the country have gone up, and therefore, jumbo loans are becoming more common.

Jumbo loans and conventional mortgages share several similarities. You will need to qualify for any mortgage, which includes a credit check, and you will need to also put down a suitable down payment at closing. The higher your credit score and the larger the down payment, the lower the rate you can obtain with both types of loan. For both types of loans, the lender will check your debt-to-income ratio, which is the total debt you pay out every month divided by your total income. The lender will also want you to prove that you have sufficient funds coming in to pay for the loan.

This is where the similarities between the two loans end. Because jumbo loans are nonconforming and higher in value than conventional mortgages, they will generally be tougher to obtain. A jumbo loan may require the borrower to have a reserve set aside that is up to twelve months’ worth of mortgage payments. A higher down payment and credit score can lower this requirement. It can also be waived if the borrower can show a low DTI or make a sizable down payment.

Jumbo Loan Pros

There are several pros that jumbo loans can provide, including:

• More funding. The biggest benefit of jumbo loans is that you can obtain more funding to purchase your dream home. This can mean the difference in getting into a high-quality property. You will also not have to take out multiple loans.
• Lower down payments. Most conventional mortgages require a down payment of 20%. However, many lenders will provide jumbo loans with only 5% and, more commonly, 10% down payments.
• Competitive interest rates. Surprisingly, even though they are larger-value loans, the rates offered for jumbo loans can be (slightly) lower than conventional loans. This is for three reasons. First, demand from investors drives down the yields on jumbos. Second, many lenders will keep these loans on their books, not selling them, which adds to their bottom line. This also means jumbos are not reliant on secondary market pricing the way conventional loans are. Finally, because they keep them on their books, lenders will be pickier as to whom they will lend to in order to reduce their risk, but they are competing for the best clients.
• Loan flexibility. Not being tied to Fannie Mae, Freddie Mac, or any wholesaler restrictions, lenders can provide borrowers more leeway, choosing what fits them best. A fixed-rate mortgage of 15-30 years is possible, or an adjustable-rate mortgage with fixed periods of 3-10 years can easily be found with jumbo loans. Other personalized options are also available.

Jumbo Loan Cons

No loan is perfect, and jumbo loans have cons as well. Here are the essential things to be aware of:

• Property vetting. You will have to vet any property to ensure it qualifies for a lender’s jumbo loan requirements. This is difficult because different lenders have different criteria and restrictions, such as no second homes, foreclosures, or short-sale homes.
• A high credit score is needed. Borrowers with a credit score of 660 or less will have a hard time obtaining a jumbo loan. This can be overcome by doing the right things to raise a score or by accumulating a larger down payment, both of which might take time to accomplish.
• Evidence of a high income is required. Because lenders are selective, they will want to see proof of a consistent annual income and personal finances to ensure payment.
• A cash reserve may be required. At the close of a jumbo loan, borrowers may need to supply (lock up) an additional 12 months of cash reserve to obtain their loan. This is insurance for the lender in case the borrower has financial troubles.

Are Jumbo Loans Harder to Qualify For?

In general, yes. Most lenders will want to see:

• A minimum credit score of 680, but some lenders require above 700.
• A DTI of 36% or less.
• Total monthly mortgage payment less than 38% of pretax income.
• A cash reserve if the down payment is under 20%.
  

Jumbo vs. Conventional — Which Is Better?

The answer depends on two questions:

1. Is the property more expensive than the conforming loan limits? If yes, then a jumbo is required.
2. Can you qualify for the jumbo loan? If not, you may need to find a less expensive home or put together a larger down payment and work to increase your credit score.

Is a Jumbo Loan Right for You?

If you are in an expensive market or have found a dream home that does not conform to the Freddie Mac or Fannie Mae limits, your only choice may be a jumbo loan, but some jumbo loans can have better rates. Being harder to qualify for, you may need to improve your credit score and put together a larger down payment or cash reserve. Even if you are eligible for a jumbo loan, it is essential to evaluate your financial and life position and confirm you are making a good choice. You would not want to get yourself into a 30-year commitment you cannot afford. You can always talk to a loan professional to help you decide.

A jumbo loan has its advantages and things to be aware of. But being an informed consumer will help you decide if a jumbo mortgage is the correct choice.