After years of building a stellar credit history, you may have decided you’re finally ready to invest in that vacation home, but you don’t have quite enough in the bank for that eye-catching property just yet. Maybe you want to begin your investment journey early so you don’t have to spend years bulking up your life’s savings.
If an aspiring luxury homeowner can’t sufficiently invest in a property with a standard mortgage loan, there’s an alternative form of financing: a jumbo mortgage. This mortgage allows those with a strong financial history who may not necessarily be a billionaire to get in on the luxury property market. But what is a jumbo mortgage (commonly known as a jumbo loan), and how exactly does it work?
Jumbo Loan Definition
A jumbo loan is a mortgage loan whose value is greater than the maximum amount of a traditional conforming loan. This threshold is determined by government-sponsored enterprises (GSE), such as Fannie Mae (FHMA) and Freddie Mac (FHLMC). Jumbo loans are for high-valued properties, like mansions, luxury housing, and homes in high-income areas. Since jumbo loan limits fall above GSE standards, they aren’t guaranteed or secured by the government. As a result, jumbo loans are riskier for borrowers than conforming mortgage loans.
Jumbo loans are meant for those who may earn a high salary but aren’t necessarily “wealthy” yet. Lenders typically appreciate this specific group because they tend to have solid wealth management histories and make better use of financial services, ensuring less of a risk for the private investor.
Due to the uncertain nature of a jumbo loan, borrowers need to present an extensive, secure credit history, as well as undergo a more meticulous vetting process if they’re considering taking out a jumbo loan. Also, while jumbo loans can come in handy for those without millions in savings, potential borrowers must still present adequate income documentation and an up-front payment from their cash assets.
Like conforming loans, jumbo loans are available at fixed or adjustable rates. Interest rates on jumbo loans are traditionally much higher than those on conforming mortgage loans. This has slowly started shifting over the last few years, with some jumbo loan rates even leveling out with or falling below conforming loan rates. For example, Bank of America’s 2021 estimates for a 5/1 adjustable-rate jumbo loan were equivalent to the same rate for a 5/1 adjustable conforming loan.
The Federal Housing Finance Agency (FHFA) has set the new baseline limit for a conforming loan to $548,250 for 2021, which is an increase of nearly $40,000 since 2020. This new conforming loan limit provides the new minimum jumbo loan limits for 2021 for the majority of the United States. As the FHFA adjusts its estimates for median home values in the U.S., these limits adjust proportionally and apply to most counties in the U.S.
Certain U.S. counties and territories maintain jumbo loan limits that are even higher than the FHFA baseline, due to median home values that are higher than the baseline conforming loan limits. In states like Alaska and Hawaii, territories like Guam and the U.S. Virgin Islands, and counties in select states, the minimum jumbo loan limit is $822,375, which is 150 percent of the rest of the country’s loan limit.
Ultimately, your jumbo loan limits and rates will depend on home values and how competitive the housing market is in the area where you’re looking to invest.
Jumbo Loan vs. Conforming Loan: Pros and Cons
The biggest question you might be asking yourself is “do the risks of a jumbo loan outweigh the benefits?” While jumbo loans can be a useful home financing resource, sometimes it makes more sense to aim for a property that a conforming loan would cover instead. Here are some pros and cons of jumbo loans that might make your decision easier.
- Solid investment strategy: Jumbo loans allow the investor to get a solid jump-start in the luxury real estate market, which can serve as a beneficial long-term asset.
- Escape GSE restrictions: Jumbo loan limits are set to exceed those decided by Freddie Mac and Fannie Mae, so borrowers have more flexibility regarding constraints they would deal with under a conforming loan.
- Variety in rates (fixed, adjustable, etc.): Though jumbo loan rates differ from conforming loan rates in many ways, they still offer similar options for what kinds of rates you want. Both offer 30-year fixed, 15-year fixed, 5/1 adjustable, and numerous other options for rates.
- Usually higher interest rates: Though jumbo loans are known for their higher interest rates, the discrepancies between those and conforming loan rates are starting to lessen each year.
- More meticulous approval process: To secure a jumbo loan, you must have a near air-tight financial history, including a good credit score and debt-to-income ratio.
- Higher initial deposit: Even though jumbo loans exist for those who are not able to finance a luxury property from savings alone, they still require a higher cash advance than a conforming loan.
How To Qualify for a Jumbo Loan
As we mentioned before, jumbo loans require quite a bit more from you in the application process than a conforming loan would.
First and foremost, most jumbo lenders require a FICO credit score of somewhere around 700 or higher, depending on the lender. This ensures your lender that your financial track record is stable and trustworthy and that you don’t have any history of late or missed payments.
In addition to the amount of cash you have sitting in the bank, jumbo lenders will also look for ample documentation of your income source(s). This could include tax returns, pay stubs, bank statements, and any documentation of secondary income. By requiring extensive documentation, lenders can determine your ability to make a sufficient down payment on your mortgage, as well as the likelihood that you will be able to make your payments on time. Usually lenders require enough cash assets to make around a 20 percent down payment.
Finally, and perhaps most importantly, lenders will also require that you have maintained a low level of debt compared to your gross monthly income. A low debt-to-income ratio, combined with a high credit score and sufficient assets, will have you on your way to securing that jumbo loan in no time.
Furthermore, you will also likely need to get an appraisal to verify the value of the desired property, in order to ensure that the property is valued highly enough that you will actually qualify for a jumbo loan.
- Jumbo loans provide a solid alternative to those with a steady financial history who want to invest in luxury properties but don’t have enough in the bank yet.
- A jumbo loan qualifies as any amount exceeding the FHFA’s baseline conforming loan limit: $548,250 in 2021.
- Jumbo loan rates are typically higher than those of conforming loans, although the gap between the two has begun to close within the last decade.
- To secure a jumbo loan, one must meet stringent financial criteria, including a high credit score, a low DTI, and the ability to make a sizable down payment.
For any financially responsible individual, it’s important to always maintain that responsibility in any investment. Each decision made should be carefully thought out, and you should keep in mind any future implications.
While jumbo loans can be a valuable stepping stone to success in competitive real estate, always make sure your income and budget are in a secure position before deciding to invest. You always want to stay realistic, and if you aren’t interested in spending a few more years saving or financing through a conforming loan, then a jumbo loan may be for you!