If you're thinking about buying a home, you’ll most likely need a mortgage. Once you’re ready to apply for a home loan, you’ll encounter dozens of mortgage terms you may be unfamiliar with. For example, you may find yourself asking what the difference is between conforming loans and jumbo loans. As you may have guessed, jumbo loans are for higher loan amounts. However, there are other distinctions to be made between these two types of home loans.
What Makes a Home Loan Jumbo?
A conventional loan can be categorized as either non-conforming or conforming. Conforming loans are specifically structured to meet the requirements of the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac), the agencies that buy up home loans to keep money circulating through the loan system. Conforming loans must meet one essential requirement to be backed by these entities — price. The Federal Housing Finance Agency (FHFA) announced in early January of 2020 that the conforming loan limits for Fannie Mae and Freddie Mac have been raised to $510,400. In high-cost markets, conforming loans top out at $765,600.
A jumbo loan is a mortgage used to finance a purchase that is higher than the local conventional conforming loan. These types of home mortgages are sometimes considered riskier for lenders because they are not guaranteed by Freddie Mac and Fannie Mae, thus leaving the lender unprotected from losses if the borrower defaults. Additionally, jumbo loans tend to require higher down payments and have stricter guidelines, and they may come with higher closing costs and fees. Despite these factors, jumbo loans are one way to buy more expensive properties that can’t be financed with a conforming loan.
Conforming vs. Jumbo Loans: The Difference and Why It Matters
If your mortgage amount is less than the upper limits set by Fannie Mae and Freddie Mac, the loan process is relatively routine because the terms of the loan conform to their standards. Jumbo loans exceed the maximum limits set by Fannie Mae and Freddie Mac. By definition, jumbo loans are non-conforming because they don't have standard terms.
Typically, jumbo loans are acquired from a large bank or a qualified online lender. The advantage of these mortgages is that it's possible to get a jumbo loan for different types of purchases, such as high-rise condos or acres of land. Still, their limits can come with drawbacks. As of 2017, home buyers are allowed to deduct interest payments on only up to $750,000 of mortgage debt. This change in interest deductions could be a sizable hit to your tax break if you were hoping to take out a jumbo loan for your next purchase.
Jumbo loans are a bit more difficult for lenders to sell on the secondary mortgage market because they don’t conform to government guidelines. Conforming loans are often easier to sell because they can be bundled and sold as mortgage-backed securities to potential investors.
Take into consideration the current limits for conforming loans, how much you can afford and the location you plan to buy before you apply. Using a mortgage calculator is a good first step to get a general idea of how much money you may be able to borrow for a home purchase.
Comparing Conforming and Jumbo Loans
Conforming Loan | Jumbo Loan | |
|---|---|---|
Loan Type | Fixed and Adjustable | Fixed and Adjustable |
Credit Requirements | Minimum score of 620 | Minimum score of 700, sometimes higher |
Income Requirements | All types of income can qualify, including self-employed | All types of income can qualify, including self-employed |
Asset Requirements | Typically 2–3 months of reserves saved | Typically 6–12 month of reserves saved |
Debt Requirements | Flexible guidelines on debt-to-income ratio | Varies; there are some situations where 49.9% DTI may be allowed, but this warrants a higher interest rate and other restrictions |
Appraisal Requirements | One appraisal needed | May be required to conduct two appraisals depending on the loan amount |
Application & Approval Process | Less complex, more standard | Complex and more specialized |
Ability for Lender to Sell on the Secondary Mortgage Market | Relatively easy because they can be bundled with other loans | More difficult because they don’t conform with government guidelines |
Conforming Loan Limits for 2020
Limits for conventional conforming loans are published annually by the FHFA. High-cost market loan limits will vary by geographic location.
2020 Limits for Conforming Loans
Number of Housing Units | Contiguous States, District of Columbia and Puerto Rico | Alaska, Guam, Hawaii, and the U.S. Virgin Islands |
|---|---|---|
1 | $510,400 | $765,600 |
2 | $653, 550 | $980,325 |
3 | $789,950 | $1,184,925 |
4 | $981,700 | $1,472,550 |
Source: Fannie Mae Loan Limits
Are There Jumbo Loan Limits for 2020?
Jumbo mortgages are available for borrowers who are looking to purchase primary residences, second homes or investment properties. These loans may be adjustable-rate mortgages (ARM) or fixed-rate loans. While conforming loans have a regulated cap, jumbo loans don’t have a national maximum. Because of this, jumbo loans are usually used by borrowers with considerable assets and earnings who make more significant real estate purchases. Additionally, banks are more inclined to grant jumbo loans to well-qualified buyers to reduce the risk of defaulting on that loan. However, newer homebuyers that exceed the conforming limit may be inclined to take advantage of current jumbo rates.
Conforming Loan vs. Jumbo Loan Rates
The rate difference between jumbo and conforming loans has fluctuated over time. As a general guideline, jumbo loans tend to be associated with slightly higher mortgage rates — somewhere between 0.25% to 0.50% higher than conforming loans. However, in the past 5–7 years, the trend has been lower interest rates for jumbo loans compared to conforming loan rates. Because jumbo loans are non-conforming, banks are able to bring rates down to attract customers.
So what’s the best move if you’re in the middle ground between both types of loans?
“If you qualify for both, go with the jumbo loan, because you will receive a better rate. In this situation, you will have a good backup in a conforming loan. It may be slightly higher, but it’s better to get a rate then no rate at all,” says Danny Sassoon, senior loan officer at Citizens Bank.
It’s essential to shop around and keep a beat on today’s interest rates for both types of loans.
Qualifying for a Jumbo Loan
Getting approved for a jumbo loan can be challenging compared to a conforming mortgage, mostly because fewer banks offer them. Additionally, the risk is generally lower on government-approved loans because they are easier to sell on the secondary market.
Scott Valins, a principal loan officer at Scott Capital Group who is licensed to originate loans in seven different states, says the jumbo loan process is unique. “Freddie and Fannie use an automated engine that spits out the guideline for a borrower whereas a jumbo loan has more of a manual underwriting process. It contains more of a human aspect. Some banks allow loan officers to massage the deal so it gets done,” says Valins. There are a few standard qualifications required to secure a jumbo loan, but your lender may have specific qualifying factors.
Jumbo Loan Qualifying Factors
Qualifying Factor | Description |
|---|---|
Down Payment | A higher down payment is required for jumbo loans. Conforming loans require as little as 3% down, while jumbo loans may require a down payment of 20% or higher depending on the borrower’s situation. |
Credit Score | Borrowers of Jumbo loans must have great credit. Jumbo lenders generally require a minimum FICO score of at least 700. |
Documentation | Qualifying for a jumbo loan will likely require the borrower to provide extensive financial documentation. This can include two year’s worth of tax returns, 1099s and W-2s, investment accounts and bank statements. |
Debt-to-income Ratio | Mortgage lenders will take a close look at your debt-to-income ratio (DTI) when applying for a loan. The cap is usually 45%, but it can go as high as 49.9% with added restrictions on jumbo products. |
Reserve Requirements | Lenders will be more willing to approve a borrower who has enough cash reserves in the bank to cover one year or more of mortgage payments. |
Key Facts About Conforming Loans and Jumbo Loans
The decision between a conforming loan and a jumbo loan corresponds to the current housing market and the buyer’s financial situation. These key takeaways should help guide you in the right direction:
- Conforming loan limits are set at $510,400 and $765,600 for high-priced markets
- The average home buyer would likely benefit most from conforming loan products
- The current market reflects lower rates for jumbo loans vs. conforming loans
- Jumbo loans are not subject to a national maximum
- Qualifying for a jumbo loan has stricter guidelines
Overall, jumbo loans are typically used by borrowers who have a robust financial sheet and are looking to make more significant purchases. The average home buyer will likely be more incentivized to stick with a conforming loan due to its less rigorous guidelines and approval process despite the slightly higher rates. In either case, conducting your own research on today’s rates and utilizing a trusted mortgage broker will enable you to make an educated decision on what type of loan is right for you.
About Harry R. Bennett III
sources
- Federal Housing Financing Agency. "FHFA Announces Maximum Conforming Loan Limits for 2020." Accessed January 20, 2020.
- Fannie Mae. "Loan Limits for Conventional Mortgages." Accessed January 20, 2020.
- Freddie Mac. "Mortgage Rates Drop to Lowest Level in Three Months." Accessed January 23, 2020.