Have you ever wondered how people can afford those million-dollar homes? Or multi-million dollar homes? Me, too. If you have ever applied for a mortgage or even looked into applying for a mortgage, you might know that getting a mortgage for around $500,000 is about the highest mortgage loans go. While that amount can buy a pretty nice house, the more expensive ones are still out of reach. If your dream home exceeds the regular mortgage limits, you might need to start looking into jumbo loans.
What Are Jumbo Loans?
In short, jumbo loans are mortgage loans that exceed the amount of money allowed by conforming home loans. These are the types of loans that you apply for if the home you wish to purchase is really high. The amounts of these two different mortgage types differ according to many things, including the area in which you hope to purchase your home.
Jumbo Loans vs Conforming Loans
There are many different types of mortgages, but these two are in reference to the size of the loans:
Regular or Conforming Loans
You have probably heard of Fannie Mae and Freddie Mac. If not, these are basically organizations sponsored by the government that have a lot of influence in the housing market. Every year, these organizations set certain guidelines that pertain to mortgages. Among other things, they set the cap on mortgage limits. If lenders provide mortgages that conform to those guidelines, aka conforming loans, then the mortgage is insured, or guaranteed by these organizations.
To simplify, Fannie Mae and Freddie Mac basically tell lenders, “As long as you meet our guidelines and do not loan more than the amount we specify, we will ensure your loans.” Most lenders choose to offer only conforming loans, as they are much less risky than non-conforming ones.
Some lenders offer jumbo loans or loans that exceed the limits of conforming loans listed below. These are not insured by Fannie Mae or Freddie Mac, meaning that the lender assumes a lot more risk. Due to this, getting approved for jumbo loans is a much more stringent process.
Conforming Loan Limits
Every year, the Federal Housing Finance Agency sets forth the conforming loan limits. Typically, these limits rise with the cost of homes and often increase every year. The conforming loan limits depend a lot on the area you are looking to purchase the home, too. In most counties, the limit in 2020 is $510,400.
However, the FHFA takes into account the higher prices of homes in high-cost areas. That loan limit can be as much as 150 percent of the base loan amount. This means that some areas in America have a loan limit of up to $765,600 for 2020. Do remember that these limits are revisited yearly, so what is listed today may be totally different if you look again next January.
What Happens When You Default On Your Mortgage
These two loan types might get a little confusing if you do not understand what it means that Fannie Mae and Freddie Mac guarantees loans. Let’s simplify as much as we can. If you take out a mortgage from your bank, you will make payments to the bank. If your bank remains your creditor and you default on your mortgage, the bank has the right to take possession of your home.
Once they do that, they have to actually do something with the home or else they are still out of the money they loaned you. Instead, they will try to sell the home to make the money back. With jumbo loans, the lender is responsible for getting their own money back.
Often, though, your bank will sell your mortgage to other investors. The bank gets their money back and the investors make the interest. As long as the mortgage fits inside of the Fannie Mae and Freddie Mac limits, these organizations take over. If you default on your loan, Fannie and Freddie still get investors their money.
Think about it like this:
Let’s say you are a teenager and your parents have put a down payment on a car for you. They tell you the following: “As long as you make it home by curfew, get your chores done, take your little brother to school, and keep your grades up, we’ll pay your car payment and insurance. If you do not meet those requirements, you can pay your own bills.”
So Fannie Mae and Freddie Mac are the parents in this situation. They tell the lender, “Hey, follow these guidelines, and we will ensure you get your money back whether the borrower pays or not.” Of course, lenders are going to want their money back, so they usually stay within those limits.
Sometimes, though, they will take the risk and go outside of those limits. If they do so, though, they want to be as close to certain as possible that the borrower will actually pay them back.
Benefits of Jumbo Loans
Jumbo loans are pretty risky, but they do have a couple of good points.
Higher Mortgage Limits
The biggest benefit of jumbo loans is the amount of money you can borrow. You are not stuck within the Fannie Mae and Freddie Mac conforming loan limits, so you can purchase a higher-priced home.
It is not unusual for a home buyer to find their dream home outside of the conforming loan limit. In fact, it happens quite often. When it does, some people choose to take out two conforming loans to cover the cost of the home. Having two separate mortgage payments to make, though, can be a hassle.
Getting one jumbo loan and spreading it out over a long time period is another option. There is something to remember here, though. The longer you pay on a mortgage, the more you pay overall in interest. If you are choosing between one jumbo loan and two conforming loans, it is important that you compare not only what the monthly payments will be, but also the total price you will pay over your entire mortgage.
Downsides to Jumbo Loans
It is important to understand the risks of jumbo loans, as well.
Higher Down Payment
Jumbo loans often require a higher down payment than conforming loans.
Higher Mortgage Limits
Yes, I know. This was listed under “Benefits”, too. Well, that’s because higher mortgage limits can be either a good thing or a bad thing. Just because you can get a higher-priced home does not mean you should. This is obviously your choice, but it is something you should carefully consider.
With any type of mortgage, you need to accept the loan you can afford, not the one the lender says you can. Think about it: you are going to be committing to this mortgage payment for a very long time. If paying $500 a month for a mortgage means you will be eating Ramen noodles every night for the next 30 years, you might want to consider a smaller loan or find a better paying job first.
Higher Interest Rates
Though this may not always be the case, it is not odd to see higher interest rates on jumbo loans since the lender is taking on so much more risk.
Jumbo loans are much harder to qualify for than conforming loans. Their credit, income, and debt-to-income ratio requirements are much more strict, making it hard for most people to get approved.
Higher Fees and Closing Costs
As jumbo loans are larger, they require a more in-depth qualification process, and they often require a second appraisal, you can expect to pay higher fees and closing costs, too.
How to Qualify for Jumbo Loans
Remember, jumbo loans are a lot riskier for lenders than conforming loans, so qualifying for them will be more difficult. While there is no guarantee that you will or will not be approved, there are some basics to know about what can help you qualify for jumbo loans.
Large Down Payment
Typically, lenders that offer jumbo loans want you to have a larger down payment. While a conforming residential mortgage may require less than a 5 percent down payment, jumbo loans may require anywhere from 10 to 20 percent. The lower the down payment you have, the higher of an interest rate you can expect to pay.
Great Credit Score
Conforming mortgages work with many different credit ratings, but jumbo loans usually do not. Though the requirement can vary from lender to lender, do not be surprised to find that many of them require a score well over 700.
Low Debt-to-Income Ratio
Let’s start by saying that most lenders that offer jumbo loans are going to prefer a high income. In addition to that, they are going to want to see that most of that income is free. In other words, if you make a lot of money but owe a lot of that money, your chances for approval are slim. The lower your debt-to-income ratio, the better of a chance you have.
Though this is not always true, many lenders want to see that you have money put away that can cover quite a few mortgage payments. Some call these cash reserves and others call them liquid assets. Regardless, having cash available to you that can ensure you make your mortgage payments can definitely improve your chances when applying for jumbo loans.
These assets may come in many forms. For instance, they might come in the form of a savings account. They might also come in the form of some type of investment. Anything you have to offer is worth mentioning to the lender. It might also save you some time if you take documentation of these assets with you to apply for your loan.
Every lender will have his or her own documentation requirements, but it is not odd for lenders of jumbo loans to require more paperwork than lenders of conforming loans. It is important to understand that these lenders are really putting their necks on the line to provide a loan, so it stands to reason that they want to dot every “I” and cross every “T”.
While other loans will require proof of income and other ordinary documents, lenders of jumbo loans may ask to see bank statements, W-2s or 1099s, tax returns, proof of your liquid assets, and more. Additionally, they may require an additional appraisal or inspection of the home prior to purchase. If you default on the loan and have your house foreclosed on, the lender will be stuck figuring out what to do with it. So, of course, they want to make sure the home is worth the price they are loaning you.
Shopping for a Mortgage
Shopping for a mortgage is a process, but you can make the process a little easier and more successful with these mortgage shopping tips:
Determine Your Budget First
I said it before and I will say it again: You need to know how much you can afford prior to applying for a loan- any loan. Before you even begin to look for a lender, sit down with your budget. If you do not have a budget, make one before you make another move. Be sure that your budget includes everything you pay out and purchase regularly.
Also, take into account any financial goals you have. This includes charitable donations, saving for a vacation, saving for college, buying your next car or TV, and so on. If it is a part of your financial plan, it needs to be added in.
Only after you have added up all of these totals should you see what is left for a house payment. You can always revisit your budget later if need be, but having a monthly amount in mind can help you make the best decision regarding the price of the home you purchase.
It is a mistake to assume that all lenders are the same. Do yourself a big favor and talk to at least three lenders that offer jumbo loans. Compare their rates, terms, and preapproval amounts. Don’t go with the first one you find, you could end up costing yourself a lot more money. If you don’t have enough time to contact different lenders, maybe you should consider taking a mortgage broker, who will find the best offer for you. Buying a house is an important part of life. It is exciting, scary, and stressful all at the same time. There are so many things that you should know when you are preparing to buy a house.
You can always count on Loanry to connect you with reputable lenders and may even make the entire process a bit easier for you. Down below, you will get a list of lenders who may give you a mortgage loan, based on the information you put in. Try it:
Do Not Rush
I know that it is really, really exciting to think about buying a home, but try not to rush the process just because you have a preapproval in hand. Remember, a mortgage is a commitment, and jumbo loans are a very big commitment. If you are going to get one, you need to be sure that you find the home you want.
Take some time to explore neighborhoods, school systems, potential employment, and so on. If a house really interests you, take time looking through it- like, really take some time. Do not just walk through it. Stop in each room and decide if it suits your needs. It is a lot easier to work hard and sacrifice for something you love year after year than it is something you do not really like. Be sure that it is worth it.
While you need to take time finding your home, it is okay to hope the actual approval process would hurry. To help it out, take any documents with you when you go into apply.
I hope that this guide has given you a good understanding of jumbo loans and has helped you determine if getting one is the right move for you. As always, before you choose to get a loan, think it through carefully. Every financial decision requires thought and consideration as they can affect your life for years to come. Since a mortgage is a debt you will be paying on for many years to come, you want to make the best decision possible.
If you feel uncertain about taking out a mortgage, you might consider talking to a financial advisor first. A financial advisor that is not connected to the lender can take a real and unbiased look at your finances and your goals. He or she can objectively tell you how much mortgage you can afford. If you do not have a financial advisor, consider talking to a trusted family member or friend who is good with numbers.