Financing Your Home Purchase
Understanding Jumbo Loans
Jumbo loans are mortgages that exceed the conforming loan limits set by the Federal Housing Finance Agency. Since jumbo loans are large loans for expensive properties, the costs are relatively higher. Jumbo loans are designed for individuals with higher incomes or who are more financially stable. To qualify, you will need to have a significant amount of savings or assets, an excellent credit history, and a low debt-to-income ratio.
How Do Jumbo Loans Work?
Banks and private investors issue jumbo loans. Typically, these lenders do not sell jumbo loans to government entities, allowing them to design their own approval criteria. Each lender has unique goals and interests, so the jumbo loan program will vary from one lender to another. Therefore, it’s wise to shop among different lenders, as you may find varying rates and approval standards.
Qualification for Jumbo Loans
Like any loan, you need to meet certain approval criteria. Jumbo loans are harder to qualify for than conventional loans. The amounts borrowed are higher, making lenders more selective due to the increased risk involved with issuing jumbo loans. Credit History: You need good credit to get approved for a jumbo loan. A FICO score of 700 is likely required, but other factors may allow for a slightly lower score. Down Payment: Jumbo loans typically require down payments of 20% or more. However, some major jumbo lenders may work with down payments of around 10%. You might even see advertisements that require lower down payment requirements. To qualify for a jumbo loan with a small down payment, you will need good credit, high and stable income, or substantial reserve assets. Income and Assets: For these large loans, lenders require documentation to prove that you have enough income and assets to cover the costs of the property you are purchasing. Ongoing income is best. Self-employed individuals need tax documents and additional information about their business, while wage-earners need W2 forms. Lenders also like to see reserve assets available to cover payments for six to twelve months. Debt-to-Income Ratio: A low debt-to-income ratio is always beneficial when applying for loans. Lenders may use 43% as a target, but this figure is not fixed. If you have substantial available assets, lenders may consider these assets (or the income from those assets) in calculating your income. Each lender will have different qualification criteria. For example, J.P. Morgan Chase requires: Excellent or exceptional credit score (FICO 800-850, Vantage 781-850), certain forms of reserves, a minimum down payment, adequate ability to repay the loan, and a debt-to-income ratio of 43% or less, with a loan-to-value ratio of 80% or less.
What Does a Jumbo Loan Cost?
Jumbo loans, due to being larger loans, come with significantly higher monthly payments as they are compressed into the same terms as smaller loans. However, costs are also much higher when considering interest rates, closing costs, and mortgage insurance, all of which depend on percentages.
Interest Rates
Historically, jumbo loans have been characterized by higher interest rates compared to conforming loans. This makes sense considering the greater risk. Additionally, approving individual borrowers who do not fit into neatly categorized tiers requires intensive efforts from lenders. However, jumbo loan rates are currently similar to conventional loan rates, and you may even find a jumbo loan with a lower rate or be able to choose between fixed and adjustable rates. Regardless, you will pay much higher amounts in interest using a jumbo loan. For example, suppose two homes have the same interest rate of 3.78% on 30-year loans. The first homeowner has a loan of $200,000, while the other has a loan of $1.2 million. Over the life of their loans, the homeowner with the $200,000 loan will pay over $108,000 in interest, while the homeowner with the $1.2 million loan will pay over $800,000 in interest.
Costs
Closing
Large loans include closing costs, just like any other mortgage loan. However, appraisal fees may be higher than average due to specialized properties or high-value purchases. In some cases, you may need two appraisals to get approval for the large loan. Closing costs typically range from 2% to 5% of the home’s value – the closing costs for a $1.2 million loan will be much higher than for a smaller loan.
Mortgage Insurance
Mortgage insurance protects lenders when borrowers default. Conventional loans and government programs typically require borrowers to purchase this insurance when making a small down payment because they may not recover all their money in case of foreclosure proceedings. But large loans are different. Whether you need to pay private mortgage insurance (PMI) on a non-conforming loan depends on the lender – some lenders may allow you to put down less than 20% without PMI.
Alternatives to Jumbo Loans
Jumbo loans are not the only way to buy a luxury home or property in hot real estate markets. If you are not excited about taking on a large amount of debt, or if you are having trouble getting approved for a jumbo loan, there may be other better options.
Stacked Loans
Instead of one large loan, you can use a combination of smaller loans. There are several different ways lenders can structure these loans: 80/20 loan: With an 80/20 stacked loan, you will receive a “first” loan for 80% of the property’s purchase price. Since you have a loan-to-value (LTV) ratio of 80%, you avoid paying mortgage insurance. The second loan covers the remaining 20% of the purchase price. 80/10/10 loan: With the 80/10/10 approach, you will also get the first loan at an 80% LTV. Then you make a 10% down payment, leaving only 10% to finance with a second loan.
Do I Need a Jumbo Loan?
While there are good reasons to take out a jumbo loan, there are some factors you may want to consider before trying to secure one.
Check the Limits
Before taking out a jumbo loan, check if you actually need it. Jumbo loans aren’t necessarily bad – again, the rates may be competitive compared to other loans. But conventional loans or government programs may be more suitable for you. If you are in a high-cost area, you can often borrow more than the “standard” limit. Some people use the term “jumbo” to refer to conforming loans in those high-cost areas, so ask for clarification when discussing your options.
Larger Down Payment
A simple way to avoid using a jumbo loan is to make a larger down payment. You only need to gather enough money to keep the loan balance below the conforming loan limit in your local area. With this approach, you have more options available, and you’ll pay less interest on the smaller loan balance. It can be challenging to gather a large amount of cash – but if you have the available funds, it may be a better option than paying interest on a large loan.
Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
Federal Housing Finance Agency. “FHFA Announces Conforming Loan Limits for 2022.” Accessed January 9, 2022.
Authority
Federal Housing Finance Agency. “Map of Conforming Loan Limits.” Accessed January 9, 2022.
Quicken Loans. “Jumbo Loan: Definition, Rates, and Limits.” Accessed January 9, 2022.
J.P. Morgan Chase Bank. “Jumbo Loans vs. Conventional Loans.” Accessed January 9, 2022.
Source: https://www.thebalancemoney.com/what-you-need-to-know-about-jumbo-loans-4155160
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