If you are considering purchasing a home that costs above $453,000, you will not be able to get a traditional government backed loan, or FHA loan. In such cases, any loan above $453,000 is called a “Jumbo Mortgage.”
In recent years, housing prices have been rising steadily, increasing the number of applications for jumbo mortgages. Each year, the federal government establishes national lending limits for traditional mortgages. In 2018, these limits are $453,000 in most counties except for a few areas where it can be as much as $675,000. Despite the added risk, jumbo loans are very useful when a traditional mortgage does not provide sufficient funds.
What Are Jumbo Loans?
Jumbo loans are mortgages that exceed national mortgage lending limits. These mortgages are not guaranteed by the government, which means lenders are not protected if borrowers default. In general, any loan can gain jumbo status if the total amount borrowed is higher than the annual lending limit.
High lending limits mean jumbo loans are not accessible to low income families. For them, a better alternative would be FHA mortgage loans, which are within the federal lending limits, eligible to be guaranteed by the government, and generally have more relaxed qualifications.
Borrowers who take jumbo loans might lose some tax benefits. For example, most homeowners are able to deduct mortgage interest payments from their taxes. However, this tax deduction only works for loans under $1 million. As loans become larger borrowers may lose access to this and other tax deductions.
The Difference Between Jumbo and Standard Loans
The main difference between jumbo loans and standard mortgages is their size. Traditional mortgages go from $25,000 to $453,000 and are guaranteed by the government. Jumbo loans start at $453,000 and have no ceiling on how much can be borrowed.
Jumbo loans are riskier than traditional mortgages, and likely carry higher interest rates as well. On average, financial institutions charge between 0.25 and 1.5 percent extra interest on jumbo loans compared to traditional mortgages.
In 2017, almost 25 percent of all mortgage applications had loan amounts that exceeded national lending limits. The reason is twofold. First, housing prices have been steadily increasing, causing a need for bigger home loans. Second, people often merge their first and second mortgages into a single jumbo loan to lower interest rates.
How To Qualify For A Jumbo Loan?
Qualifying for a jumbo loan requires more paperwork than traditional mortgages. For example, most financial institutions will finance home purchases to customers with FICO scores around 600 points. FHA loans bring the number down to around 500. In contrast, jumbo mortgages require a score of 700 or better.
Debt-to-income ratio (DTI) is another value financial institutions take into consideration. It represents how much income goes into monthly debt payments, including credit card bills, car loans and mortgages. For example, someone earning $30,000 each year, paying $875 a month to debt accounts, will have a 35 percent debt-to-income ratio.
Although lenders can be flexible with debt-to-income ratio, most deny customers who are above 45 percent. This is because lenders prefer when borrowers do not carry too much debt, as it often negatively impacts their ability to cover monthly payments.
Standard mortgage lenders do not verify if borrowers have cash reserves. In some cases, such as when approving FHA loans, borrowers might receive financial support to cover down payment. However, financial institutions have a different approach with jumbo loans. Borrowers must prove they have enough cash reserves to cover at least twelve monthly payments. That in addition to down payment money.
Benefits of Jumbo Loans
The main benefit of a jumbo mortgage is that it allows borrowers to sidestep lending limits. In the past, jumbo mortgages were less common but, rising home prices have made jumbo mortgages a relatively new norm.
Jumbo mortgages are also very useful to homeowners who cannot request a second mortgage without exceeding lending limits. For example, a family might have acquired a property in New York City using a government-backed mortgage loan. However, their property is now valued at a price higher than the local lending limit. Applying for a second mortgage would not take advantage of the property’s entire equity. Refinancing into a larger jumbo mortgage would be a more efficient solution.
Jumbo mortgages also have cash benefits tied to them. Although financial institutions are cautious when issuing jumbo mortgages, most allow down payments of around 10 percent without private mortgage insurance. Wells Fargo is among the best known lenders to follow this practice. Smaller institutions like U.S. Bank prefer a safer approach though, asking borrowers 20 percent down payment to avoid private mortgage insurance. Borrowers are advised to shop around before submitting an application for financing. Buying a home outside of the federal limits may cost you more than expected.