What is a Jumbo loan?
A jumbo loan, also called 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 cannot 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 subscription requirements and tax implications. These types of mortgages have gained ground as the housing market continues to recover after the Great Recession.
The value of a jumbo mortgage varies by state and even county. The FHFA sets the size of the conforming loan limit for different areas on an annual basis, although it rarely changes. In 2019, the limit was set at $ 484,350 for most of the country. This was increased by $ 453,100 in 2020. For counties that have higher residential values, the reference 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 benchmark limit for a jumbo loan in Alaska, Guam, Hawaii and the U.S. Virgin Islands in 2019 is also $ 726,525. This amount may actually be even higher in counties that have higher housing values.
How a jumbo loan works
If you’re targeting a house that costs almost half a million dollars or more – and you don’t have much on a bank account – you’re probably going to need a jumbo mortgage. And if you are trying to get one, you will face much more stringent credit requirements than homeowners who apply for a conventional loan. This is because jumbo loans carry more credit risk for the lender as there is no collateral by Fannie Mae or Freddie Mac. There are also more risks because more money is involved.
Like traditional mortgages, the minimum requirements for a jumbo have become increasingly stringent since 2008. To be approved, you will need an excellent credit score – 700 or more – and a debt-to-income ratio (DTI) very low. The DTI must be less than 43% and preferably closer to 36%. Although these are non-conforming mortgages, the jumbos must still follow the guidelines of what the Consumer Financial Protection Bureau considers a “qualified mortgage” – a lending system with standardized terms and rules, like the DTI at 43%.
You will need to prove that you have accessible cash to cover your payments, which will likely be very high if you choose a standard 30-year fixed rate mortgage. Income levels and specific reserves depend on the size of the overall loan, but all borrowers need 30 days of pay stubs and W2 tax forms that date back two years. If you are self-employed, the income requirements are more important: 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 mortgage payments. And all applicants must present appropriate documentation on all other loans held and proof of ownership of illiquid assets (such as other real estate).
Key points to remember
- A jumbo loan is a type of financing that exceeds the limits set by the Federal Housing Finance Agency and cannot be purchased, guaranteed or securitized by Fannie Mae or Freddie Mac.
- Homeowners face more stringent credit requirements than those applying for a conventional loan.
- Approval requires an excellent credit rating and a very low debt-to-income ratio.
- The average APR for a jumbo mortgage is often comparable to a conventional mortgage, while down payments represent around 10% to 15% of the total purchase price.
Jumbo loan rates
While jumbo mortgages previously carried higher interest rates than conventional mortgages, the spread has narrowed in recent years. Today, the average annual percentage rate (APR) for a jumbo mortgage is often comparable to a conventional mortgage – and in some cases, actually lower. In March 2019, Wells Fargo, for example, charged a APR of 4.092% on a 30-year fixed rate compliant loan and 3.793% for the same term on a jumbo loan.
Even if government-sponsored companies cannot manage them, jumbo loans are often securitized by other financial institutions; as these securities are more risky, they are traded at a return premium compared to conventional securitized mortgages. However, this spread has been narrowed with the interest rate on the loans themselves.
Down payment on a Jumbo loan
Fortunately, the down payment requirements have eased over the same period. In the past, giant mortgage lenders often required home buyers to pay 30% of the purchase price of the home (compared to 20% for conventional mortgages). Now that figure has dropped from 10% to 15%. As with any mortgage, there can be various benefits to paying a higher down payment, including avoiding the cost of private lenders who request down payments of less than 20%.
Who should take out a jumbo loan?
The amount you can ultimately borrow depends, of course, on your assets, your credit score, and the value of the property you want to buy. These mortgages are considered the most suitable for a segment of high income earners who earn between $ 250,000 and $ 500,000 per year. This segment is known as HENRY, an acronym for high income, not yet wealthy. Basically, these are people who generally make a lot of money but have not yet accumulated millions of cash or other assets.
While an individual in the HENRY segment may not have amassed the wealth to buy an expensive new home with money, these high-income individuals generally have better credit scores and a more widely established credit history than the average home buyer looking for a conventional mortgage for a lower amount. They also tend to have more solidly established retirement accounts. They often contribute longer than low-income earners.
Don’t expect a big tax break on a jumbo loan. The limit on mortgage interest deduction is limited to $ 750,000 for new mortgage debts.
These are just the types of people that institutions love to buy long-term products, in part because they often need additional wealth management services. In addition, it is more convenient for a bank to administer a single mortgage of $ 2 million than 10 loans worth $ 200,000 each.
Special considerations for a jumbo loan
Just because you can qualify for one of these loans doesn’t mean you have to withdraw one. You certainly shouldn’t do this if you’re counting on it to provide you with substantial tax relief, for example.
You probably know that you can deduct the mortgage interest you paid for a given year from your taxes, provided you detail your deductions. But you probably never had to worry about the cap the IRS places on this deduction – a cap that was lowered by the passage of the Tax Reduction and Jobs Act. Anyone who took out a mortgage on December 14, 2020 or earlier can deduct interest on up to $ 1 million in debt, the amount of the old limit. But for home purchases made after December 14, 2020, you can only deduct interest up to $ 750,000 in mortgage debt. If your mortgage is larger, you don’t get the full deduction. If you plan to take out a $ 2 million jumbo mortgage that earns $ 80,000 in interest per year, for example, you can only deduct $ 30,000 – the interest on the first $ 750,000 of your mortgage. In fact, you only benefit from tax relief on 37.5% of mortgage interest.
This means that you need to borrow carefully and carefully figure out the numbers to see what you can really afford and what types of tax benefits you will receive. With the state and local tax deduction limited to $ 10,000 per year, due to the same tax bill, a highly taxed property will also cost you more. Another strategy: compare the conditions to see if getting a smaller compliant loan, plus a second loan, instead of a big jumbo, might be better for your long-term finances. (For related reading, see “Understanding Jumbo and Conventional Mortgages”)