Buying a home in today’s economic environment can be an incredibly stressful process. Home prices around the country are on the rise which means that borrowers will need to take out larger and larger mortgages to get the home of their dreams. If the size of your home loan exceeds a certain amount, you may need to seek a jumbo loan instead of a conventional mortgage.
How To Qualify for a Jumbo Loan
- Credit score
- Debt-to-income ratio
- Cash reserve
- Appraisals (multiple are possible)
- Financial documentation
- Loan-to-value ratio
Jumbo loans are more difficult to qualify for, but due to rising home prices, they may be becoming more common. Even modest homes in some areas of the country will require a jumbo loan. Because they’re for a higher loan amount, your mortgage payment will be higher and your lender will be taking on more risk backing the loan. Additionally, not all lenders offer jumbo loans so you may have to shop around before you find a loan program that works for you.
What Is a Jumbo Loan?
A jumbo loan is a home loan that exceeds the limits set out by Fannie Mae and Freddie Mac, two of the largest government-sponsored companies in the country that guarantee home loans. Currently, these two companies account for over 62% of loans made and the federal government sets their conforming loan limits (the highest amount a borrower can qualify for a loan under the Federal Housing Finance Agency (FHA) guidelines.) The loan limit on these mortgages is currently $647,200 for most borrowers, but there are certain counties with higher-than-average home prices where the conforming loan limit is significantly higher. For example, in parts of California like San Francisco and Los Angeles County the conforming loan limit is $970,800 as it is in parts of New York.
A jumbo home loan (also called a non-conforming loan) is therefore needed when borrowers wish to buy a home where their loan amount would be over this limit. Mortgage lenders are not required to offer jumbo loans to borrowers because they don’t come with the same government-backed guarantees that conforming loans do. This means the lender is taking on more of a risk by providing you with the money and in response, will likely have stricter requirements for qualifying.
In most cases, the annual percentage rate (APR) will be comparable to a conforming loan, but this will vary widely depending on your lender and your creditworthiness. Some borrowers may see higher interest rates for a jumbo loan while others will see lower interest rates.
Advantages of a Jumbo Loan
Jumbo loans have many advantages. If you can qualify for one and can comfortably cover your monthly payment, it may be a great option. These loans allow you to borrow more money than a conventional loan which in turn makes a larger house, property, investment property, or multi-family home available to you. While this may equate to a mansion or luxury home in certain parts of the country, in other expensive markets it may look more like a modest home in a nice neighborhood.
Jumbo loans will also often have options for down payments under 20% (some as low as 5%) which can save borrowers money upfront. They also allow borrowers to consolidate their loan under one lender instead of cobbling together several smaller loans to cover the purchase price of their home.
Disadvantages of a Jumbo Loan
It should be noted that when you’re taking out a loan for such a high amount, there are certain disadvantages to consider. The most obvious is the financial obligation that you’re taking on and the responsibility to make large monthly payments. If you get behind on these payments or default on your loan, the repercussions will be much greater than they would be with a traditional loan.
In some cases, you may be looking at higher loan rates than with a conventional loan and the jumbo loan requirements for credit scores will be much stricter. There will also be higher costs all around in terms of closing costs and down payments due to the sheer amount of money being borrowed. Even if you’re only putting down 10%, with an $800,000 loan, that’s $80,000 you’ll have to cover out-of-pocket. This high cost of a down payment may also mean you have to carry mortgage insurance on your loan. Some lenders require any borrower who puts down less than 20% to purchase mortgage insurance until the loan-to-value ratio (LTV) is at 80/20.
How To Qualify for a Jumbo Loan
Qualifying for a jumbo mortgage is more difficult than a conventional loan, and you should be aware of these requirements before you start shopping for homes.
Because the lender is taking on more responsibility when they provide a jumbo mortgage loan, you typically must have a high credit score. The average credit score of a jumbo loan recipient is 740. However, some may qualify with a credit score in the high 600s if the rest of their finances are strong. In most cases, a recent bankruptcy or foreclosure will exclude you from qualifying for a jumbo loan unless it has been at least 7 to 10 years since it happened.
Your debt-to-income ratio (DTI) is another measure lenders will use to determine your creditworthiness. Your DTI compares your gross monthly income and determines how much of it is used for regular debt payments like car loans, rent, credit card debt, and other recurring payments. This percentage will then be assessed alongside your credit score when a lender is evaluating your application. Lenders will be looking for a low DTI which means that you have more cash each month to cover new financial obligations like a mortgage. Typically, it should be lower than 40%. If you have a higher credit score it can help to offset a higher DTI, and likewise, a very low DTI can help offset a lower credit score.
The third factor that a loan officer will look for is how much money you have in a cash reserve. Lenders may want to see that you’re able to cover your monthly mortgage payments for a certain period of time (for example 6 to 12 months) in case something happens to your source of income. Bear in mind that you should have this amount in savings in addition to your closing costs and down payment.
Most types of mortgage loans will require an appraisal of the home before the lender will officially approve the loan. This is added insurance on the lender’s part to reduce the risk of the borrower defaulting. They want to make sure that the home has a high value since it serves as their collateral if the borrower can’t honor the loan. And, the higher the amount of your loan the higher the likelihood the lender will order more than one appraisal. Typically with a mortgage loan of over $1 or $2 million, the lender will order two appraisals and these are fees the borrower usually has to cover. Also, if you need multiple appraisals, know that this might delay the closing timeline.
With any loan type, you’ll need to provide several pieces of financial documentation and a jumbo loan is no different. Lenders will want to see your tax returns for the last two years, your last two pay stubs (or profit/loss statements for those who are self-employed), at least two months of bank statements, and any other proof of income.
Your loan-to-value (LTV) is determined by your appraisal and it tells your lender the difference between the loan amount and the purchase price of the house. The lower the LTV, the better the investment is for your lender. A low LTV can also secure you a better interest rate because it poses less of a risk to the lender. Oftentimes, a jumbo loan rate can be 0.5% to 1.0% higher than a conventional loan, but a low LTV paired with a high credit score and low DTI can make the two mortgage rates comparable.
Is a Jumbo Loan Right for Me?
Deciding to buy a home or piece of real estate is a big decision for anyone, regardless of what loan option you pursue. However, for those who need to borrow over $650,000, the only option available to them may be a jumbo loan. Borrowing so much money presents a substantial financial risk both to you and to the lender, and you should seriously consider whether a jumbo loan is right for you. When considering a loan this large, speak with a financial advisor about how to get a mortgage loan that works for your needs and your budget.
Only those with a substantial income, high credit score, and low DTI should think about a jumbo loan. Additionally, you’ll likely have to put down a large down payment which means you’ll need a considerable amount of cash reserves. Jumbo loans can be useful for those who wish to buy luxury homes or investment properties like a multi-family residence, but they may also be necessary for those who want to buy a home in a county where home prices are significantly higher.
There are also opportunities for veterans who may wish to take out a larger loan. Traditional jumbo loans exceed the loan limit set by the FHA and are therefore not protected in the same way that conforming loans are. However, a VA jumbo loan works just like a regular VA loan and will be guaranteed through the Government National Mortgage Association (GNMA). While the specific requirements for a VA jumbo loan will vary by lender, it can offer borrowers the same advantages as a VA loan including a $0 down payment for qualified buyers.
Jumbo loans are also available in the form of a reverse mortgage. These loans are typically offered to older homeowners over the age of 62 who have gained a large amount of equity in their high-value homes. This would then allow the owner to borrow against the value of their home (up to $4 million).
On the other hand, even if you can qualify for a jumbo loan, it may not always be the best decision financially. The monthly mortgage payments on jumbo loans can be quite high and if you can’t (or don’t want to) cover these costs for the life of your loan, then you may want to consider a conforming loan for a smaller home.