How Jumbo Loans Can Help You Buy High-Priced Homes

Image by Adrian Mangel © The Balance 2019 

A jumbo loan is a home loan that is larger than “conforming” loans that lenders sell to Fannie Mae and Freddie Mac. Instead of using maximums set by government-sponsored entities (GSEs), jumbo loans are issued by private lenders. Those lenders set their own rules for approval and often hold the loans as investments.

Most importantly for home buyers, jumbo loans make it possible to buy more expensive homes. You might not care about mortgage markets, but if you’re buying a high-priced home and you don’t make a sizeable down payment, a jumbo loan may be your best option. You might even get a better interest rate with a non-conforming loan.

Why Large Loan Balances Are Called Jumbo-Sized Mortgages

Jumbo loans get their name from the large loan balances available. Conforming loans, which are the largest segment of loans in the U.S., are loans that meet guidelines set by GSEs.

Those loan amounts for 2019 are capped at $484,350 in most parts of the country and have additional rules on borrower qualification. In some high-cost areas, loan limits go much higher to account for local housing markets. For example, in Los Angeles County, the 2019 limit is $726,525.

If you want to borrow more than the loan limit in your area, you’ll need to use a jumbo loan or another creative method to secure financing.

Jumbo Lenders Have Individual Goals

Banks and other private investors issue jumbo loans. Those lenders have no intention of selling the loans to GSEs, so lenders can design their own approval criteria. Every lender has unique goals and concerns, so every jumbo loan program is different. That means that it’s essential to shop among various lenders, as pricing and approval criteria can vary widely.

Find a lender that fits your financial situation and the property you’re buying. For example, some lenders make it easier or harder to get loans for second homes, and different lenders have different down payment requirements.

Qualifying for Jumbo Mortgages

As with any loan, you’ll need to meet the approval criteria, and jumbo loans are more difficult than conventional loans to qualify for. The loan amounts are higher, so lenders are more selective due to the increased risk of issuing jumbos.

  • Credit History: You’ll need good credit to get approved for a jumbo loan. A FICO score above 700 is a minimum for most buyers, but other factors could warrant a slightly lower score.
  • Down Payment: Jumbo mortgages typically require down payments of 20 percent or more. However, some mainstream jumbo lenders will work with down payments around 10 percent, and others advertise programs with even lower requirements. To qualify for a jumbo loan with a small down payment, you’ll need good credit, strong income, or significant reserve assets. With most lenders, down payment requirements increase as loan sizes increase.
  • Income and Assets: For these large loans, lenders require documentation to prove that you have sufficient income and assets to afford the property you’re buying. A consistent income is best. Self-employed individuals need tax documents and additional information about their businesses, and wage-earners need W2 forms. Lenders also like to see reserve assets available to cover payments for six to 12 months.
  • Debt-to-Income Ratio: A low debt-to-income ratio is always helpful when applying for loans. Lenders commonly use 43 percent as a target, but that number is not set in stone. Especially if you have significant assets available, lenders might consider those assets (or the earnings from those assets) as part of the income calculation.

Jumbo loans are not designed to help borrowers “stretch” and buy more house than they can afford. Instead, they’re for financially secure borrowers buying homes that are more expensive than average.

What You Pay for a Jumbo Loan

  • Interest Charges: Historically, jumbo loans featured higher interest rates than conforming loans. The risk is greater as loan sizes increase. Plus, approving one-off borrowers who don’t fit into tidy categories is labor-intensive. However, since the mortgage crisis, private lenders have found that jumbo borrowers may actually be lower-risk borrowers, and they can be profitable customers in a variety of ways. As a result, rates on jumbo mortgages may be lower than rates on conforming loans. Still, with jumbo-sized loan balances, you can easily pay more in interest costs than somebody with a smaller loan at a higher rate.
  • Jumbo loans are available with fixed or variable rates.
  • Closing Costs: Jumbo loans feature closing costs, just like any other home loan. Appraisal fees, in particular, may be higher due to specialized properties or high-dollar purchases. In some cases, you’ll need two appraisals for jumbo loan approval.
  • Mortgage Insurance: Mortgage insurance protects lenders when borrowers default on a loan. Conforming loans and government programs typically require borrowers to buy this insurance when making a small down payment because the ability to recover funds in foreclosure is questionable. But jumbo loans are different. Whether or not you’ll need to pay private mortgage insurance (PMI) on a non-conforming loan is up to the lender—some allow for less than 20 percent down with no PMI.

Alternatives to Jumbo Loans

Jumbo loans aren’t the only avenue to buying luxury homes or properties in hot real estate markets. If you’re not eager to borrow that much, or if you’re having trouble getting approved for a jumbo loan, a different approach may be better.

Piggyback Loans: Instead of one large loan, you can use a combination of smaller loans. These strategies have made a comeback since the mortgage crisis. But unlike pre-2008 piggyback loans, you’ll now need to prove that you have the ability to repay each loan.

  • 80/20 Loan: With an 80/20 piggyback loan, you’ll get a “first” mortgage for 80 percent of the property’s purchase price. Because you have an 80 percent loan-to-value (LTV) ratio, you avoid paying PMI. The second mortgage will cover the remaining 20 percent of the purchase price.
  • 80/10/10: With an 80/10/10 approach, you also get the first loan at 80 percent LTV. However, you’ll also make a 10 percent down payment, leaving only 10 percent to borrow on a second mortgage.

Piggyback loans solve the problem of paying PMI, but you’re still borrowing large sums of money. To get approved, you need high credit scores—but you might qualify with FICO scores in the high 600s. Interest rates on second mortgages tend to be higher than rates on first mortgages, so your borrowing costs may be higher with this strategy. Compare those costs with other options using a loan calculator or an amortization table.

Be aware that some piggyback arrangements use balloon loans. For example, you might need to pay off one or both loans or refinance within 15 years.

Verify Limits: Before you resign yourself to using a jumbo mortgage, verify that you’ll actually need one. Jumbo loans aren’t necessarily bad—again, you might even get a better interest rate. But conforming loans or government programs might be a better fit for you. If you’re in a high-cost area, you can often borrow much 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 mortgage is to make a bigger down payment. You just need to come up with enough to bring your loan amount down below your local conforming loan limit. With that done, you’ll have more options available, and you will pay less interest with a smaller loan balance. Raising a significant amount of cash is easier said than done, especially as the dollar amounts grow. But if you have funds available, it may be an attractive option.