If you’re in the market to buy a home, but need a loan for high amounts, you may need a jumbo loan. The name sounds ominous, and most people believe jumbo loans are impossible to qualify for or are too expensive. Neither is true. Jumbo financing is a great financial tool if you’re in the market to buy a home that exceeds the standard loan limits. Here’s everything you must know about jumbo financing, how it works, and whether it’s right for you.
What is a Jumbo Morgage Loan?
A jumbo loan is financing for a home that’s higher than the conventional limit. In 2022, the conventional loan limit is $647,200. Any loan higher than this amount requires jumbo financing or non-conforming financing.
The exception to this rule is high costs areas such as California. For example, in Los Angeles, the conventional loan limit for 2022 is $970,800
The premise is the same for conforming and non-conforming loans – you must qualify for financing, but because it’s unconventional, there aren’t any government agencies backing up the lender. Fannie Mae and Freddie Mac back up or guarantee conventional loans. If a borrower defaults, they have the bank’s bank, ensuring they don’t lose their neck on the deal.
Jumbo lenders don’t have this guarantee which is why they have tougher requirements to ensure you can afford the higher loan payment and terms. It’s a precaution for you and the lender. You don’t want to get into a loan you can’t afford as much as they don’t want to lend you the money you can’t afford to pay back.
How Does a Jumbo Mortgage Work?
Jumbo financing works on all home types including single-family homes, condos, and townhomes. You can use the financing to buy a home or refinance an existing home. You can even use it as a cash-out loan, tapping into your home’s equity.
Jumbo Loans for a Home Purchase
Just like any loan, you must prove you qualify for the loan to use jumbo financing for a home purchase. Most jumbo loans are available from $548,251 to $2.5+ million. It’s possible to borrow more than $2.5 million too, but with even tougher qualifying requirements since the risk of default increases with the loan amount.
Jumbo Loans for a Rate and Term Refinance
A rate and term refinance are a refinance to either lower your interest rate or change the loan’s term to make it more affordable. In 2021, for example, millions of people refinanced their loans because interest rates dropped so low, even for jumbo loans. It was a great opportunity for many people to save money on interest and/or make their loan payments more affordable after a difficult year.
The rate and term refinance are also great for those who need a different term. Whether you took a 15-year term but it’s more than you can afford or you took a 30-year term but can afford more now, you can take advantage of the current low rates and refinance the loan.
With the jumbo rate and term refinance, you don’t take any cash out of your home’s equity. You simply restructure your loan so that it’s more affordable or to help you save money on interest over the life of the loan.
Jumbo Loans for a Cash-Out Refinance
If you have equity in your home (you owe less than the home’s value), you may tap into it with a cash-out refinance.
Unlike conventional loans, though, you’ll need more equity before you can tap into it if you need a jumbo loan. The amount varies, but, you’ll need at least 30% equity before you can take equity out of your home.
Cash-out refinance loans have higher interest rates and tougher qualifying requirements because of the risk they cause. But if you’ve invested most of your money in your home and now need it for an emergency or future expense, a cash-out refinance may be an option.
How to Qualify for a Jumbo Loan
The question everyone wants to be answered is ‘how do I qualify for a jumbo loan?’ You know the requirements are tougher, but what do you need? Here’s a quick breakdown.
Minimum Credit Score
The exact credit score you need varies based on your loan amount and qualifying factors, but in general, borrowers need a 700+ credit score.
In other words, you need great credit to get jumbo financing. Again, it’s to account for the risk jumbo loans create. A borrower with a great credit score poses a lower risk of default which means you’re less likely to end up in foreclosure.
If you don’t have a 700+ credit score, you may still qualify if you have compensating factors or factors that make up for the risk a lower credit score creates.
Maximum Debt-to-Income Ratio
The next largest factor when determining your eligibility for a jumbo loan is your debt-to-income ratio. This compares your gross monthly income to the debts you have outstanding plus the new mortgage.
The DTI measures how well you can afford the mortgage. A high DTI means you may not be able to afford the mortgage, and a low DTI means you have more affordability and are at a lower risk of default.
The exact DTI needed varies by borrower, but overall, a 40%-45% DTI is the maximum most borrowers can have to secure jumbo financing.
If you’re employed by someone, you must be able to prove your employment with paystubs, W-2s, and a verbal/written Verification of Employment. If you are self-employed, you must provide proof of your income with your bank statements and tax returns. You’ll also need a statement from a third party, such as your CPA stating you are self-employed and the income you reported is accurate.
All borrowers must prove their assets by providing the last couple of months of bank statements. The bank statements must show the assets you claimed on your application and the deposits should be in line with the income you claim too. If there are large deposits, you may need to write a Letter of Explanation to explain where the deposits came from and to prove they are not funds from another loan.
Some borrowers need cash reserves to qualify for jumbo financing. Reserves are money you have set aside ‘just in case.’ If you lost your job or had other financial issues, the cash reserves could help cover your mortgage payments. Cash reserves are calculated based on the number of mortgage payments it could cover.
For example, if your mortgage payment is $2,000 and you have $16,000 in reserves, you have 8 months of mortgage payments set aside. This can help your chances of loan approval.
All jumbo loans require an appraisal and the appraisal must state the home is worth at least as much as you agreed to pay if you’re buying the home. If you’re refinancing, it must be worth enough for you to refinance your current loan and still have the required amount of equity in it.
Sometimes jumbo financing requires a second appraisal to ensure the first appraisal was an accurate reflection of the current market rates.
Jumbo Loans vs Conforming Loans
Since you must jump through a ton of hoops to get jumbo financing, you may wonder how it differs from conforming loans since they too have strict requirements. Here are the largest differences.
Conventional loans are usually more lenient than jumbo loans because there’s less at risk and Fannie Mae or Freddie Mac backs up the loan. While you still need good credit, it doesn’t need to be perfect.
The largest difference is the loan amount (the amount you can borrow). Conventional loans only go up to $548,250 (except for certain high-cost areas), whereas jumbo loans go much higher. Both loans, however, only allow you to borrow the amount you can afford. The limits are a generalization and aren’t a guarantee that you can borrow as much.
Stricter Underwriting Guidelines
Jumbo financing has stricter underwriting guidelines including a larger down payment, lower debt-to-income ratio, and more cash reserves. Both loans use compensating factors to make up for a ‘bad factor,’ such as a low credit score or high DTI, but jumbo financing may be less forgiving than conventional.
Pros and Cons of the Jumbo Loan
Like any mortgage financing option, there are pros and cons of the jumbo loan that you should understand.
- You can borrow more money, allowing you to buy a more expensive home. This is helpful especially in high-cost areas where the home prices greatly exceed the conforming loan limit.
- You can avoid taking out two loans as conforming loans would require. With two loans, you’d need a first loan for 80% of the sales price and a second loan, such as a home equity loan for the remainder minus your down payment.
- There are many loan options including fixed-rate and adjustable-rate loans, as well as 15 – 30 year term options, giving everyone a chance to choose the loan that suits them.
- Jumbo loans still have the flexibility and great interest rates. As long as you work with a quality lender, you’ll get the same flexibility you’d get on a conventional loan.
- You need great credit. A 700-credit score is typically the lowest you can have to qualify for the financing, which for some people is unachievable.
- You need a lot of cash reserves. Conventional loans don’t require cash reserves for most borrowers, but jumbo financing may require reserves of 3 to 6 months of mortgage payments for you to qualify.
- You need a large down payment. This ties up your money in your home which isn’t liquid. If you need to access the cash, you’ll need to qualify for a mortgage refinance or sell the home.
Are Jumbo Loan Interest Rates Higher?
Everyone wants to know about the interest rates. If the risk is higher on a jumbo loan, the rates are likely higher too, right?
They could be, but it’s not a necessity. When you work with a quality lender, you may secure competitive interest rates compared to conventional loans. The key is having great qualifying factors.
The lower your credit score and debt-to-income ratio, the higher your chances of securing a low-interest rate. If you have less-than-perfect qualifying factors, determine what compensating factors you may have that can offset the risk so you can secure the competitive interest rates.
Is a Jumbo Loan Right for You?
If you’re buying a home in an expensive market and don’t have the down payment to bring your financing needs below the conventional or high-cost limit you’ll need jumbo financing.
It’s not right for everyone since it is more expensive. Even with low-interest rates, the principal payment itself is higher than a traditional loan, so exercise caution before taking out a jumbo loan.
Make sure you can afford the payment not only today but, in the future, too. You’ll likely have the mortgage for 15 – 30 years, so think about your future. Will you have the same income or higher? Will you go down to one income when you start a family? Do you want a mortgage that takes up a large portion of your income?
Answering these questions honestly can help you choose the right mortgage. If you decide jumbo loans are the way to go, work with a reputable lender that offers competitive interest rates, forgiving guidelines, and exceptional service. A mortgage is one of the largest personal finance decisions you’ll make in your lifetime so make sure it’s an informed decision.