What is a jumbo loan?A jumbo loan is a mortgage that exceeds the limits of conventional conforming loans. The Federal Housing Finance Agency (FHFA) sets the limits of conventional conforming loans each year for specific regions of the U.S. These loans are bought/guaranteed by Congress-backed Fannie Mae and Freddie Mac in the secondary loan market from primary lenders. Congress does not provide any guarantee to the lender for jumbo loans. Therefore, lenders have strict eligibility requirements and higher APR to counter the risk premium. So, why choose a Jumbo Loan? A jumbo loan can be used to purchase your dream house. Jumbo loans can help finance such purchases if you meet the eligibility criteria. Lenders won't put a maximum cap on your borrowing limits if you have the financial ability to serve the loan repayment.
How Does A Jumbo Loan Work?Congress-backed Fannie Mae and Freddie Mac provide stability, affordability, and liquidity to the U.S. real-estate market by guaranteeing home loans below a specific limit. The Federal Housing Finance Agency (FHFA) has set $647,200 as a conventional conforming loan limit for 2022. Some special areas like Guam, Hawaii, Alaska, and the U.S. Virgin Islands have a higher conventional conforming loan limit of $970,800 for 2022. The market for jumbo loans is small and concentrated. In some neighborhoods, the starting price of housing is too great for a conventional home buyer. Traditional banks bridge this gap by providing jumbo mortgage loans to finance any home beyond the FHFA loan limit. The lender takes an independent risk of default or a fall in home prices. According to its risk management policy, each lender develops unique eligibility criteria for jumbo loans. To make sure that they remain profitable in the long run, jumbo loan providers follow stricter guidelines and may charge a higher interest rate. However, jumbo loans can be processed without insurance since the bank underwrites the entire loan on its own. For the borrower, a jumbo loan is the ultimate luxury product. It is usually for High Net Worth (HNI) individuals and professionals staying in neighborhoods with a high cost of real estate.
Jumbo loan limitThere is no standard cap on limits for jumbo loans. Lenders provide jumbo loans based on the risk assessment of borrowers. If you have a good credit score, good income, low debt, and high cash reserve, you can be a perfect candidate for a jumbo loan. You may even get a lower APR than a traditional mortgage because jumbo loan providers allow insurance-free mortgages and lower appraisal charges. Most lenders offer fixed interest rates on jumbo loans, but the rates have increased since 2020 with rising inflation. Lenders charge APR between 4.48-5.76% for new homeowners and 4.57-5.93% for refinancing a previous mortgage. This rate is indexed at a 20% down payment over a repayment period of 30 years. You can get slightly better jumbo loan rates if you offer more down payment and take less repayment period.
Why Are Jumbo Mortgages Treated Differently?Jumbo mortgage is a niche product that lenders carefully monitor. They are treated differently because the lender has a higher risk and higher reward in jumbo loans. Banks usually charge an extra premium to take the higher risk on behalf of the borrowers. A jumbo loan may not be marketed as much as traditional mortgages because there is only a small percentage of borrowers for jumbo mortgages. However, borrowers are more prone to fraud and mis-selling since there is limited regulation regarding jumbo loans. If you plan to mortgage a jumbo loan, read through the fine print before finalizing repayment terms.
Jumbo vs. Conventional loanA jumbo loan offers several benefits to eligible borrowers. There is no maximum cap on financing, and you can mortgage a property worth millions with a jumbo loan. You are also not required to pay the standard 20% down payment on most jumbo loan mortgages. Jumbo loans are custom-made to suit the borrower, and some lenders can finance up to 95% of the home value. You can put in extra as a down payment, reducing your future loan payments. You can also save on private insurance if you put in more than 20% as a down payment. However, you need to show a higher cash reserve and lower debt-to-income ratio than most conventional mortgages.
|Parameters||Jumbo Loan||Conventional Loan|
|Loan Limit||Up to millions. Set by individual lenders||Up to $647,200 for most parts of the US. Up to $970,800 for Guam, Hawaii, Alaska, and the U.S. Virgin Islands|
|Minimum Downpayment||5% of loan value||20% of loan value|
|Cash Reserve||As high as 24 months of borrower’s expenses.||0-6 months of borrower’s expenses|
|Appraisal Requirements||Based on lender’s risk management policy||Has to be appraised by an FHA-approved appraiser.|
|Maximum Debt-to-Income Ratio||43%||50%|
|Purpose||Can be used as real-estate investment||Primary residence|
Jumbo Loan Requirements & credit scoreA jumbo loan is provided to individuals who show a track record of growing income. Each loan application is individually evaluated, and requirements may be personalized. However, here are some standard requirements that lenders ask for while assessing a jumbo loan.
- Credit Score- 700 and above
- Debt-to-Income Ratio- Maximum acceptable DIT is 45%
- Cash Reserve- At Least 12 months of borrower's living expenses
- Disposable Income- More than 40% of income after deducting monthly expenses
- Second Valuation- You may be required to provide a second appraisal on your mortgage.
- Co-Signer- You may bring a co-signer and combine your incomes together to get a better jumbo loan deal.
ConclusionA jumbo loan is an ambitious mortgage that you may take when you have sufficient disposable income, high cash reserve, or strong future growth prospects in your career or business. You can be paying a higher premium for jumbo loans, but it is to counter the higher risk involved. Jumbo loans can be a gray area of regulations, so it's best to read through the loan documents before committing to a jumbo loan.