Over the last two years, property prices have soared. According to Zillow, the average home price now is over $300,000. In some places, it can be double this amount.
To make sure that home buyers have more leeway and support, many lenders offer a special type of home loan called jumbo mortgage.
What Is a Jumbo Mortgage?
Jumbo mortgage is a term used in the United States to refer to mortgages above what’s usually referred to as conforming loan limits.
Conforming loan limits are the maximum mortgage amounts you can buy with Fannie Mae or Freddie Mac. The baseline conforming loan limit changes from time to time, depending on factors like inflation.
As of January 1, 2022, the maximum takeout from a lender under the Freddie Mac and Fannie Mae programs is $647,200, which is almost a hundred thousand dollars more than the previous year.
However, the actual limits can vary from state to state or even county to county. In places where home prices are high, such as in New York or California, the limits are likely to be above the baseline. On the contrary, properties in rural areas may have a much lower conforming limit.
What Are the Benefits and Drawbacks of Jumbo Mortgage?
The benefits of taking out a loan above the conforming limit are numerous. First, you have more housing options since you can now buy properties with a higher price tag. This is especially true in times when it’s a hot seller’s market, where the demand for homes is high but the supply is low, skyrocketing property prices.
It also indicates that you can potentially purchase a house with a considerable value in the market. This way, if you decide to sell it, you can look forward to a handsome profit.
Many lenders also see these home loans as a good source of income, so you can avail them at competitive rates and other terms.
Opting for a jumbo mortgage also provides you access to the same benefits offered in other types of home loans. For instance, you can pay a lower down payment with private mortgage insurance (PMI), look for a mortgage with a lower interest rate, or pay 20 percent down to get rid of PMI.
Despite the benefits, jumbo mortgages also have some drawbacks. Since these are bigger loans, they can be harder to qualify for. You may also need to have a significantly lower debt-to-income ratio.
You also have to pay higher interest rates compared to other home loan types, which means you’ll have a higher monthly payment. Therefore, you need to ensure that your cash flow can support the additional expense.
Jumbo mortgages also require private mortgage insurance (PMI) if you put down less than 20 percent on the purchase price of the house. PMI protects lenders in case of default by covering some of the loss until the homeowners make payments for 80 percent of their loan’s value.
This requirement makes it more difficult for active buyers with lower credit scores, as there is no guarantee they will get approved for a jumbo loan at low rates like those with excellent credit scores.
How to Qualify for a Jumbo Loan
You may need to get a loan from a private lender if you want to purchase a jumbo property. This makes it more difficult to qualify for the loan, but two main factors can impact your chances of being approved: credit score and debt-to-income ratio.
Your credit score is one of the most important things lenders will look at before approving your application for a mortgage. Their goal is to determine whether you have the financial discipline and ability to repay what you owe, so they want borrowers with good scores, typically over 700.
Secondary to the above factor is the debt-to-income ratio. Since jumbo loans are bigger than typical mortgages, lenders consider this ratio when determining how much you can borrow. For instance, 30 percent is considered a good DTI if the loan amount takes up less than 50 percent of your income.
Meanwhile, if your monthly debt payments are at least half of what you earn every month, then it makes sense for lenders to assume that you will repay the loan in full and on time.
You may also need to put down additional money when applying for jumbo loans. This sum varies depending on the lender, but some require a 20 percent down payment.
A jumbo mortgage has many benefits, including access to properties that are above the baseline value, making them perfect for high-priced areas or luxury homes. But it also comes with drawbacks, which home buyers should consider before they apply.