Jumbo Loans
What is a Jumbo Loan?
A jumbo loan, also known as a jumbo mortgage, is a type of financing that exceeds the limits set by the Federal Housing Finance Agency (FHFA). Unlike conventional mortgages, a jumbo loan is not eligible to be purchased, guaranteed, or securitized by Fannie Mae or Freddie Mac. Designed to finance luxury properties and homes in highly competitive local real estate markets, jumbo mortgages come with unique underwriting requirements and tax implications. These kinds of mortgages have gained traction as the housing market continues to recover following the Great Recession.
The value of a jumbo mortgage varies by state—and even county. The FHFA sets the conforming loan limit size for different areas on an annual basis, though it changes infrequently. As of 2019, the limit was set at $484,350 for most of the country. That was increased from $453,100 in 2018. For counties that have higher home values, the baseline limit is set at $726,525, or 150% of $484,350.
The FHFA has a different set of provisions for areas outside of the continental United States for loan limit calculations. As a result, the baseline limit for a jumbo loan in Alaska, Guam, Hawaii, and the U.S. Virgin Islands as of 2019 is also $726,525. That amount may actually be even higher in counties that have higher home values.
How Does a Jumbo Loan Work?
If you have your sights set on a home that costs close to half a million dollars or more—and you don't have that much sitting in a bank account—you're probably going to need a jumbo mortgage. And if you’re trying to land one, you’ll face much more rigorous credit requirements than homeowners applying for a conventional loan. That’s because jumbo loans carry more credit risk for the lender since there is no guarantee by Fannie Mae or Freddie Mac. There's also more risk because more money is involved.
Just like traditional mortgages, minimum requirements for a jumbo have become increasingly stringent since 2008. To get approved, you’ll need a stellar credit score—700 or above—and a very low debt-to-income (DTI) ratio. The DTI should be under 43% and preferably closer to 36%. Although they are nonconforming mortgages, jumbos still must fall within the guidelines of what the Consumer Financial Protection Bureau considers a “qualified mortgage”—a lending system with standardized terms and rules, such as the 43% DTI.
You’ll need to prove you have accessible cash on hand to cover your payments, which are likely to be very high if you opt for a standard 30-year fixed-rate mortgage. Specific income levels and reserves depend on the size of the overall loan, but all borrowers need 30 days of pay stubs and W2 tax forms stretching back two years. If you're self-employed, the income requirements are greater: Two years of tax returns and at least 60 days of current bank statements. The borrower also needs provable liquid assets to qualify and cash reserves equal to six months of the mortgage payments. And all applicants have to show proper documentation on all other loans held and proof of ownership of non-liquid assets (like other real estate).
Jumbo Loan Rates
While jumbo mortgages used to carry higher interest rates than conventional mortgages, the gap has been closing in recent years. Today, the average annual percentage rate (APR) for a jumbo mortgage is often par with conventional mortgages—and in some cases, actually lower. As of March 2019, Wells Fargo, for example, charged an APR of 4.092% on a 30-year fixed-rate conforming loan and 3.793% for the same term on a jumbo loan.
Even though the government-sponsored enterprises can't handle them, jumbo loans are often securitized by other financial institutions; since these securities carry more risk, they trade at a yield premium to conventional securitized mortgages. However, this spread has been reduced with the interest rate of the loans themselves.
Down Payment on a Jumbo Loan
Fortunately, down payment requirements have loosened over the same time period. In the past, jumbo mortgage lenders often required home buyers to put up 30% of the residence's purchase price (compared to 20% for conventional mortgages). Now, that figure has fallen as low as 10% to 15%. As with any mortgage, there can be various advantages to making a higher down payment—among them, to avoid the cost of the private mortgage insurance lenders require for down payments below 20%.
Who Should Take Out a Jumbo Loan?
How much you can ultimately borrow depends, of course, on your assets, your credit score, and the value of the property you're interested in buying. These mortgages are considered most appropriate for a segment of high-income earners who make between $250,000 and $500,000 a year. This segment is known as HENRY, an acronym for high earners, not rich yet. Basically, these are people who generally make a lot of money but don't have millions in extra cash or other assets accumulated—yet.