Financing for Homes in High-Cost Areas
Finding the Right Home Loan: What are Jumbo Loans
As the name suggests, jumbo loans are big mortgages. They are generally designed for affluent borrowers who are well-heeled enough to afford $1 million homes, but not so wealthy they can pay cash. But for many buyers in high-cost areas, such as San Francisco or New York City, a jumbo loan might be the only option that the average buyer has available to finance the purchase of a home.
You may be able to qualify for a jumbo loan, but is it the right decision? You'll need some hefty reserves to get a jumbo loan, but can you afford to pay a higher-than-normal mortgage for the next 15 or 30 years, not to mention higher taxes and homeowners insurance? What would happen if you lose your well-paying job and have trouble finding another one? If you think you'll need to spend down your reserves on renovation or a child's college, you might want to find a home that has an in-law unit that you could rent out should you need extra income to tide you over.
The qualification requirements for jumbo loans are stringent. Lenders demand higher credit scores and a larger down payment compared to smaller, conforming loans.
In 2019, most borrowers who want a mortgage exceeding the maximum $484,350 loan guaranteed by Fannie Mae and Freddie Mac will need a jumbo loan.
In high-cost areas like parts of California and New York, loans above $726,625 are considered jumbo. The limits vary by county and are set by the Federal Housing Finance Agency (FHFA). Basically, any loan falling within FHFA's limit is called a conforming loan, which means it can be bought and sold by mortgage giants Freddie Mac or Fannie Mae. Anything larger is considered a jumbo, or nonconforming, loan
Read on to get a better understanding of jumbo loans, including who offers them, how to qualify and how to decide whether you should take a fixed-rate or adjustable-rate jumbo loan.
What Do I Need to Qualify for a Jumbo Loan?
Conventional lenders allow borrowers to put down as little as 3 percent, but because there's no private mortgage insurance to protect jumbo lenders from default, they normally require 20 percent down. Although you might find a bank willing to take 15 percent and - on rare occasions - even 10 percent, expect to pay a higher rate for that concession.
A FICO score of 700 out of 850 is the bare minimum for most jumbo lenders. Some will go as low as 680, but you'll pay a much higher interest rate, perhaps as much as two or three percentage points. Redwood Trust, a large buyer and packager of jumbo loans, says the average FICO score of its borrowers was 772 as of the end of 2015.
Jumbo lenders require a bigger cushion, represented by lower limits on debt-to-income ratios for jumbo borrowers. Jumbo lenders typically require total debt-to-income ratios of 43 percent or less.
You'll need hefty reserves to get a jumbo loan. For borrowers with subpar credit or low down payments, the reserve might be as much as 20 percent of the amount of the loan. Others might need to have as much as 18 months of principal, interest, taxes and insurance on hand. If you're taking an $800,000 loan for 30 years at a fixed rate of 4 percent, you might need to show $70,000 in reserves. However, the entire amount need not be in cash - your retirement assets can count toward the reserve requirement.
Generally, documentation requirements for jumbos are similar to what you'd provide for a conforming loan - tax returns, pay stubs, bank statements and brokerage account statements. However, jumbo loan applications typically are subjected to a more thorough, more time-consuming review so expect 45 to 60 days to close. Some lenders have strict rules about approving borrowers who've had short sales or foreclosures within the past seven years, so it's probably wise to disclose any hiccups in your financial past.
How Hard Is It to Get a Jumbo Loan?
The jumbo market has loosened considerably in recent years, but lenders are still picky about who they give money to because they're likely to keep your loan. Conforming loans usually are sold to Fannie and Freddie, which turn them into mortgage-backed securities, but jumbo loans are more likely to stay in the lender's portfolio - hence the higher level of caution.
Part of the reason they're more stringent is that they are lending their own money rather than Fannie and Freddie's money," says Mathew Carson, vice president at First Capital Group in San Francisco. "They definitely have guidelines that make it a bit tougher, but if you check all those boxes, it's a relatively painless process.
How to Find a Jumbo Lender
Big banks such as Wells Fargo, Citi, Chase, Bank of America and US Bank actively offer jumbo mortgages. Some stockbrokers, credit unions and community banks also make jumbo loans.
But terms can vary widely, so it pays to shop around, both on your own and with a mortgage broker.
You can really run into some quirky guidelines that you wouldn't expect from other lenders," says Scott Schang, branch manager at Buywise Mortgage in Anaheim, California. "If you've got perfect credit and your debt-to-income ratios are really low, you're shopping for rate.
Carson suggests starting with an institution where you've already established a relationship. "If you're a high net-worth borrower and you have good assets at your bank, they are going to bend over backwards to keep your portfolio with them," Carson says. "If you go directly to your bank, you're going to get a better rate than you can get elsewhere. They'll do what they can to get you a red-hot deal."
Jumbo Loan Rates
Since the jumbo loan market isn't as large and robust as the market for conforming loans, jumbo loans tend to be more expensive - typically by an eighth of a point or a quarter point. However, the gap can vary with fluctuations in global markets and with the type of loan you're seeking. If a jumbo lender agrees to extend credit to borrowers with lower credit scores, the lender also might raise the interest rate by two to three percentage points.
Should I Refinance My Jumbo Loan?
The sheer size of jumbo loans means it might make financial sense to refinance even on a slight downtick in rates. "There's definitely greater value in refinancing jumbo loans," says Keith Gumbinger, vice president at HSH.com.
Say you're considering refinancing your 30-year fixed-rate mortgage to 4 percent from 4.5 percent.
- On a $200,000 loan, you'd save $58 a month in principal and interest. That's probably not enough to spur you to action, especially after considering the effect of extending the loan term and the cost of refinancing.
- But on an $800,000 loan, you'd save $234 a month - enough to lease a car for your child or pay some additional bills.
Fixed Rate Vs. ARMs
With mortgage rates still near record lows, most borrowers opt for the safety and peace of mind offered by a fixed-rate loan. An adjustable-rate mortgage (ARM) can be tempting, however, because of its lower rate in the early years of the loan. Say you're borrowing $800,000, and you're weighing a fixed-rate loan at 3.75 percent against an adjustable-rate loan at 3 percent.
- For the first five years, the ARM will be cheaper by $332 a month, or nearly $20,000 over 60 months.
- If the ARM resets in five years, the rate could climb above 3.75 percent. So you should consider how long you plan to hold the mortgage:
- If you're buying a small condo but think you'll have a family within five years and plan to move, an ARM might make sense.
- If you plan to be in this house for more than five years, the fixed-rate loan might be wiser. You could face severe "payment shock" with an ARM, says the Federal Deposit Insurance Corp.: "Your payment may go up a lot - as much as double or triple - after the interest-only period or when the payments adjust. Be comfortable that you'll be able to make your loan payments on an ARM if the interest rate soars to the highest level it could go while you own your home." (The lender has to disclose the maximum interest payments you could face within three days of receiving your application, so do the math.)
- The FDIC also notes the risks of another type of ARM, called a payment option ARM, which was popular pre-crisis. The payments made under this type of loan may not cover all the interest owed and can lead to negative amortization - meaning you'll wind up owing more on your mortgage than you originally borrowed.
You also need to consider your own appetite for volatility. "How much risk are you willing to take?" asks Eric Tyson, author of Mortgages for Dummies. "The advantage with a fixed-rate mortgage is you know from day one what your payment is going to be, and it's not going to fluctuate."
How Interest-Only Jumbo Loans Work
Post-recession reforms made it harder for lenders to issue interest-only loans, but there are still some lenders who offer them. With these mortgages, you pay no principal, just interest, and the monthly savings can be hefty.
- Borrow $800,000 with a five-year ARM at 3 percent, and your monthly payment will be $3,373.
- Use an interest-only loan at 3 percent, and the payment plunges to $2,000.
Interest-only loans appeal to a certain type of borrower, particularly folks who don't mind a little risk and prefer to invest their money in stocks rather than in home equity. Carson, for instance, has an interest-only loan on his home in San Francisco. "I take the savings and invest it," he says. Generally, interest-only loans are employed as a strategy by affluent investors, but they also can be used as an affordability gambit.
But Tyson steers borrowers away from interest-only loans. With these mortgages, you're not paying down the principal, leaving you at greater risk of being underwater on your mortgage.
The other problem with interest-only loans is that at some point you have to either refinance your way out or pay it off
FHA Jumbo Loans
For a brief time, the Federal Housing Administration provided jumbo loans in certain areas. Owing to a quirk of loan limits, FHA issued mortgages for up to $729,750 in high-cost counties, a sum that exceeded the $625,500 limit another agency, the Federal Housing Finance Agency, imposed on Fannie Mae and Freddie Mac. FHA guidelines allow for down payments of 3.5 percent and FICO scores in the low 600s, so FHA loans were a boon to borrowers who couldn't qualify for conventional jumbo loans. FHA loans have a major drawback, however - steep mortgage insurance premiums that must be paid for the life of the loan.
The fleeting era of the FHA jumbo is gone, mortgage brokers say. FHA's loan limits for a single-family home are now at $726,525 in the priciest counties, matching the conforming loan limits in other programs.
Teachers and Public Servants: Additional Options in High-Cost Areas
Since the jumbo market operates outside the purview of the government, it offers little or nothing to teachers, nurses and other critical workers who live in expensive areas and want to buy a home. That means middle-income workers can find it difficult to afford homes in expensive areas such as New York and San Francisco.
One option: Down payment assistance programs. In some high-cost markets, these programs are open to borrowers with six-figure incomes. For instance, in Santa Clara County, in the heart of California's Silicon Valley, the National Housing Foundation's Sapphire program offers down payment assistance for buyers who make up to $122,245 a year.
VA Jumbo Loans
VA loans tend to offer generous deals to veterans, and that extends to jumbo loans. Rates are competitive with those of standard jumbo loans and require much lower down payments.
The borrower is only required to put down 25 percent of any amount above the conforming limit.
- So, if a veteran in a high-cost area borrows $1.126 million, he'd have to make a down payment of $100,000, or 25 percent of the $400,000 gap between the $726,525 conforming-loan limit and the loan amount.
It's a really good deal," Schang says. "You won't get another product like that.
Counseling When Getting a Jumbo Loan
Housing counseling isn't just for borrowers in financial distress. Many HUD-approved housing counselors provide a service called pre-purchase housing counseling.
A mortgage expert will look at the terms of your offer and make certain you're not being taken advantage of by your lender. "We're neutral, and we can give you objective advice," says Melinda Opperman of Springboard Nonprofit Consumer Credit Management, a California-based organization that offers counseling nationwide. The nonprofit counseling organizations are funded with money from the federal government, but you might have to pay a small fee for the services. Opperman says her organization's charges top out at $50, a small price to pay for peace of mind - particularly in the case of jumbo mortgages. You can find a list of HUD-approved housing counselors here.
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