Financing for Homes in High-Cost Areas
Jumbo Loans: Key Things You Need to Know
A jumbo loan is a type of mortgage that exceeds the Federal Housing Finance Agency’s (FHFA) limits. Use MoneyGeek’s guide to learn how jumbo loans work and see if you can qualify for one.
A jumbo loan or jumbo mortgage is used to finance a high-value property. These loans are ideal for individuals who make enough to afford million-dollar properties but cannot pay in cash. A jumbo loan may be the only way to afford a home in some cities with competitive real estate markets, like New York or Los Angeles.
While jumbo loans grant you access to expensive properties, they also carry higher-than-normal payment requirements, stringent rules and unique tax implications. It’s smart to learn more about jumbo loans, how they work and their requirements before considering them an option.
Jumbo loans are a financing method for high-value properties, with borrowing amounts exceeding FHA’s limits.
Requirements for a jumbo loan are more stringent than traditional loans, requiring higher down payments and cash reserves along with more documentation.
Jumbo loan limits vary depending on your lender, but rates are similar to a traditional loan in that you can get fixed or adjustable rates.
What Are Jumbo Loans?
Jumbo loans provide an option to finance high-value properties that conventional conforming loans cannot. Conforming loans are mortgages that fall within the dollar limit set by the Federal Housing Finance Agency (FHFA), which is currently $647,200 for most counties.
Since jumbo loans do not follow the FHFA limits, they are considered non-conforming loans and have varying amounts depending on your state, county or lender. Government-backed mortgage companies Fannie Mae (Federal National Mortgage Association or FNMA) and Freddie Mac (Federal Home Loan Mortgage Corporation or FMCC) do not back jumbo loans.
Freddie Mac and Fannie Mae buy conforming mortgages from banks and other financial institutions. The movement of money ensures that lending institutions can continue to write more mortgages and help more people buy homes.
Because they are not government-backed, the requirements for a jumbo loan can vary and are typically strict. Lenders are at a higher risk of losses if the borrower defaults on their payment. This also makes the market for jumbo loans significantly smaller.
Aside from these major differences, jumbo loans and traditional mortgages still generally function the same way. The borrower can opt for either a fixed or adjustable rate for their jumbo loan. To find the most favorable terms, a borrower can shop around and compare lenders.
Jumbo loans can finance high-value properties, including your primary residence, a secondary home, a vacation home or an investment property. If you can afford the payments, this type of financing is also a great way to enter the real estate investing market.
How Does a Jumbo Loan Work?
Jumbo loans provide more borrowing power than conforming loans, giving you access to property with a higher price tag. Whether you want to live in an upscale, luxury home or an area with an expensive housing market, a jumbo loan can help you afford the higher costs. However, jumbo loan rates are higher than conventional mortgages and have more stringent requirements and unique tax implications.
Jumbo loans may require an excellent credit score, high income and, sometimes, large cash reserves or assets. Actual requirements vary based on your lender, loan amount and employment situation.
FHA Jumbo Loans
For a time, the Federal Housing Administration (FHA) provided jumbo loans in certain areas. This let low-credit score individuals take out an FHA loan exceeding the agency’s limits while enjoying a down payment of just 3.5%. However, it did have a drawback: steep mortgage insurance premiums that had to be repaid over the life of the loan.
Jumbo loans from the FHA are typically not available. In its place are increased “ceiling” limits of $970,800. However, actual limits can vary depending on location, as there are also maximums contingent on your ZIP code. A loan officer can help you determine what is possible in the area where you want to purchase a home.
VA Jumbo Loans
Veterans can benefit from several discounted or generous deals from financial institutions, and this is true for jumbo loans. A VA jumbo loan is simply any VA loan that exceeds the county’s preset limit.
VA loans are backed by the U.S. Department of Veterans Affairs, as they guarantee payment of up to 25% of your loan amount if it exceeds $144,500, should you default. VA loan limits do not represent a cap or maximum loan amount.
When a veteran has full entitlement, a lender may agree to loan them as much as they like without requiring a down payment. However, veterans who already have one or more VA loans or have defaulted on a previous VA loan will be subject to the limits, partly determining their reduced down payment.
For jumbo loans, lenders set their own limits, which can be between $2.5 million and $3 million. To maximize your loan and get the highest limit possible, look for local lenders specializing in the housing market in your desired location. This is easier if you’re looking at high-cost areas.
Jumbo Loan Rates
Since the market for jumbo loans is smaller than the traditional mortgage market, lenders typically set higher rates. If lenders offer a jumbo loan to a low-credit individual, this can increase by two to three percentage points. Some market conditions allow lenders to follow conforming mortgage rates or set a lower rate.
Fixed-Rate vs. ARMs
Similar to conforming mortgages, jumbo loan rates can be fixed or adjustable. A fixed-rate loan comes with fixed interest throughout the life of the mortgage, while an adjustable-rate mortgage (ARM) undergoes interest rate changes after a certain period, usually three to five years.
The benefit of either type of mortgage for you will depend on how long you intend to hold the loan. For example, let’s say you are borrowing $800,000 with a $40,000 down payment over a 30-year term, but you’re weighing a 3.75% fixed interest against 3% adjustable rates.
Payments for the First Five Years (Year 1 to 5)
In total, you would save around $18,960 in the first five years if you choose an ARM. However, if your rate increases beyond the fixed rate, you may spend more instead of saving. The chart below shows how this can change over the next five years if your ARM interest increases to 3.85%.
Payments for the Next Five Years (Year 5 to 10)
If your rate increases, you may end up spending $6,480 more than you would with a fixed-rate loan. This shows why it is valuable to consider how long you’ll hold the loan. If you intend to carry your loan for 15 years, you may only see rate changes three to five times. However, if you intend to hold your loan longer than 25 years, you may be better off with a fixed-rate loan.
Jumbo Loan Requirements
Jumbo loan requirements are similar to the requirements for a conventional loan, but lenders are typically stricter given their increased risk. Lenders may increase their credit score requirement or ask for a higher down payment. They may also want to see proof of cash reserves.
Learn about the requirements for a jumbo loan below.
Conventional lenders allow borrowers to put as little as 3% down, but jumbo lenders may require as much as 20% down because no private mortgage insurance protects them from default. Some banks may be willing to allow you a 10% or 15% down payment, but this is rare and comes with higher rates.
Most jumbo loan lenders require a FICO score of 700 out of 850. Some lenders will accept a score of 680, but the interest rate will be higher, around two or three percentage points. This serves to prove that you are reliable and will make on-time payments, which is necessary for lenders given the increased risk on their end.
Debt-to-Income (DTI) Ratio
Your debt-to-income (DTI) ratio indicates how much debt you have compared to your income. To qualify for jumbo loans, lenders require you to have a bigger financial safety net, represented by lower debt-to-income ratios. Typically, a DTI ratio of 43% or less is best to qualify for a jumbo loan, but some lenders may be flexible if you have a lot of cash reserves.
Cash reserves are a must for any jumbo loan borrower, as they mean you are less likely to default. If you have a poor credit score or a low down payment, the reserve requirements may be 20% of the loan amount.
In some cases, lenders may require 18 months of principal, interest, taxes and insurance. You might need to show $70,000 in reserves to obtain an $800,000 loan at a fixed rate of 4% for 30 years. However, not all cash reserves have to come from your bank account. Retirement assets can also be counted toward your reserve requirement.
Tax returns, pay stubs, bank accounts, and brokerage account statements are typically required for jumbo loans, just as they are for conforming loans. On the other hand, jumbo loan applications are often put through a more rigorous, time-consuming evaluation. The process could take between 45 and 60 days for approval.
Because some lenders have stringent requirements regarding borrowers who have had short sales or foreclosures in the last seven years, it's best to mention any financial problems up front.
Under the Tax Cuts and Jobs Act, homeowners who purchased their homes after Dec. 14, 2017, can only deduct the interest on up to $750,000 in mortgage debt. With a jumbo loan, your tax break may not be substantial, so it’s important to crunch the numbers to maximize your tax benefits. When applying for a jumbo loan, keep this in mind, as they can involve more indirect costs than conforming loans.
Frequently Asked Questions About Jumbo Loans
Understanding how jumbo loans work can be confusing, especially since requirements are more stringent. Review the most frequently asked questions about jumbo loans below.