If you're looking for expensive property, you may need a jumbo loan. Jumbo loans are available for borrowers when a conventional mortgage doesn't cover the costs of the property they want to buy.
These loans are needed when the loan amount surpasses loan limits defined by the government. A jumbo loan may be necessary if you want to buy a luxury home, a house in areas with higher home values, or need to refinance a current home mortgage with a large balance.
In this guide, you'll discover everything you need to know about jumbo loans, the conditions for approval, and how to decide if it's right for you.
What Is a Jumbo Loan?
A jumbo loan (or jumbo mortgage) is financing that surpasses the limits defined by FHFA (Federal Housing Finance Agency). It isn't qualified to be purchased, guaranteed, and securitized by Freddie Mac or Fannie Mae.
Jumbo loans are created to finance homes in highly competitive local real estate markets and luxury properties and come with special underwriting conditions and tax implications. The jumbo mortgage value changes by state but also by the county.
The FHFA determines the conforming loan limit size for distinct areas annually. $647,200 was the limit set for most of the counties in 2022. For counties with higher home values, the limit is $970,800. A good example of this is many counties in California, so you might wish to learn more about jumbo loans in California to find out how it works exactly.
The limit for areas outside the continental US is also $970,800, but it may be higher in counties with higher home values.
How Jumbo Loans Work
Let's say you want a house that costs $600,000, but you don't have that much in a bank account. So, you will likely need a jumbo loan. However, if you're trying to lend it, you'll encounter more demanding credit requirements than someone requesting a conventional loan because jumbo mortgages are riskier for lenders.
That's because more money is involved, but also because there's no guarantee by Freddie Mac or Fannie Mae. You'll need a 700 credit score or above and a low DTI (debt-to-income) ratio - under 43%, but ideally closer to 36%. Jumbo loans still fall within the policies of what CFPB (Consumer Financial Protection Bureau) deems a qualified mortgage.
You'll have to verify you have available cash to make the mortgage payments. These can be pretty high if you choose a typical 30-year fixed-rate mortgage. Specific income levels and cash reserves depend on the size of the loan. However, every borrower needs 30 days of pay counterfoils and W-2 tax forms from the last two years.
If you're self-employed, the income demands are bigger - 2 years of tax returns and 60 days or more of current bank statements. Also, you will need provable liquid assets and reserves equal to 6 months of the payments. Moreover, all candidates must display actual documentation on other loans and proof of non-liquid assets.
Jumbo Loan Rates
The average APR (annual percentage rate) for a jumbo loan is usually the same as conventional loans and sometimes lower.
Other financial institutions often securitize jumbo mortgages as the government-sponsored enterprises can't manage them. These securities involve more risk, so they trade at a yield premium to conventional loans.
Down Payment on Jumbo Loans
Down payment conditions have relaxed recently. Before, lenders often needed home buyers to put up 30% of the residence's purchase price. Now, that figure is as low as 10% to 15%. There can be advantages to making a higher down payment as with every mortgage. One of them is avoiding the private mortgage insurance lenders' cost for down payments below 20%.
Who Is Suitable for a Jumbo Loan?
How much you can borrow depends on your credit score, assets, and the value of the property you want to buy. Jumbo mortgages are most suitable for high-income earners who annually earn between $250,000 and $500,000 - people who make a lot of money but don't possess millions in extra cash and other assets yet.
This part of earners is known as HENRY (high-earners, not rich yet). HENRY individuals may not have the wealth to buy an expensive home with cash. Still, they typically have higher credit scores, and more confirmed credit histories than the average buyers looking for a conventional mortgage for a lower amount.
Also, they often have more solidly established retirement accounts. And, typically, they have been contributing for a more extended period than average income earners. The institutions love to sign up these individuals for long-term products because they need extra wealth management services. In addition, it's more practical for a bank to issue a single $3 million mortgage than ten $300,000 loans.
Jumbo Loan and Interest Deduction
You probably know that you can deduct the mortgage interest you paid for any given year from your taxes if you itemize your deductions. However, you likely didn't have to worry about the cap the IRS puts on this deduction - a cap that the passage of the Tax Cuts and Jobs Act lowered.
Everyone who purchased a home on December 14th of 2017 or earlier can deduct interest on up to $1 million in mortgage debt. But, for mortgages made after that date, you can deduct only $750,000 in debt.
You don't get a full deduction if your loan is bigger. For instance, if you take out a $2 million jumbo loan accruing $80,000 in interest annually, you can only deduct $30,000, which is the interest on the first $750,000 of your loan. That means you only get a tax break on 37.5% of the mortgage interest.
Therefore, you should calculate carefully to know what you can afford and what tax benefits you will get. With the local and state tax deduction limited to $10,000 a year because of the same tax bill, a highly taxed property will cost you more.
It's a good idea to compare the terms and see if two smaller loans instead of one jumbo will be better for your finances in the long run.
The Bottom Line
Jumbo loans are loans that surpass the conforming loan amounts set by FHFA. The costs are higher because they are significant loans for expensive properties. They are designed for financially stable individuals with higher incomes.
You'll need an excellent credit score, a low debt to income ratio, and a significant amount of assets or savings to qualify for a jumbo loan.
Also, you don't get a full interest deduction if your loan is larger than $750,000. So, before purchasing anything, calculate carefully and consider all the factors, and base your decision on that.
Published by Goran Kezić