If the next home you plan to purchase comes with a particularly steep price tag, you may need to apply for a jumbo mortgage to finance it. These loans, often more than half a million dollars and up, are designed to finance luxury properties and homes in a highly competitive local real estate markets and come with unique underwriting requirements and tax implications.
But, aside from being big, what exactly are jumbo loans or mortgages, and how do they differ from their conventional, less-sizeable counterparts?
Fannie Mae, Freddie Mac, and Loan Limits
These two agencies will securitize (that is, purchase, package and resell) virtually any mortgage so long as it adheres to their “conforming loan” guidelines, which factor in a borrower’s credit score and history, debt-to-income (DTI) ratio, the mortgage’s loan-to-value ratio, and one other key factor: the size of the loan. As of 2017, the national maximum for conforming loans is $424,100 for a single-unit dwelling. However, more than 208 counties around the U.S. are designated as high-cost, competitive areas (think New York City, Los Angeles, Nantucket); in these, the maximum loan limits can reach $625,500.
When mortgages exceed these thresholds, that’s when they receive their “jumbo” status. Keep in mind, however, that while jumbo mortgages fall outside conforming loan restrictions and won’t be backed by Fannie Mae or Freddie Mac, many still adhere to the guidelines for “qualified mortgages” set in January 2014 by the Consumer Financial Protection Bureau.
Qualifying: Conventional vs. Jumbo Mortgages
Because jumbo loans aren’t backed by federal agencies as conventional mortgages are, lenders are taking on more risk when they offer them. This means you’ll face more stringent credit requirements if you’re trying to secure one. Most lenders will want to see the following:
- Proof of income: Come prepared with two years’ worth of tax documentation or similar paperwork proving you have a reliable, consistent source of income. Lenders will also want to see you have enough liquid assets on hand to cover six months' worth of mortgage payments or more.
- Sterling credit score and history: Generally you need a credit score of at least 620 (considered “fair”) before a lender will approve you for a conventional mortgage. However, there’s a low probability lenders will approve you for a jumbo mortgage if your credit score falls below the 700-720 range, although there is some evidence this is beginning to change.
- Debt-to-Income ratio (DTI): Since most conventional mortgages are also qualified mortgages, your debt-to-income ratio (your monthly debt obligations compared to your monthly income) needs to be 43% or less. This same rule would apply for jumbo mortgages that are also qualified mortgages, but often lenders will want you to have a lower DTI since the loan is so large. (See How does my debt-to-income (DTI) ratio affect my ability to get a mortgage?)
- Down payments: A couple of years ago, jumbo mortgage lenders would have required higher down payments – around 30% or more – compared to conventional mortgages, which are typically 20%. However, the ratio of down payments to mortgage value has relaxed for both categories, with major lenders such as PNC Financial Services Group and Wells Fargo recently offering jumbo mortgages for as little as 15% and 10.1% down, respectively.
In recent months, the average annual percentage rate (APR) for a jumbo mortgage has more or less been on par with conventional mortgages. In fact, it’s not uncommon to see a lower APR for a jumbo mortgage.
To compare jumbo mortgage rates, it's useful to use a mortgage calculator like the one below.
The Tax Bill
If you’re already a homeowner, you’re probably aware that you can deduct from your taxes the interest you paid on your mortgage for any given year. But you probably never had to worry about the cap the IRS places on this deduction.
Yes, you can deduct mortgage interest – as long as the mortgage itself is $1 million or less. If your mortgage is larger, you don't get the full deduction. For example, if you took out a $2 million jumbo mortgage that accrues $60,000 in interest a year, you can only deduct $30,000 – the interest on the first million of your mortgage. So, you only get a tax break on half the mortgage interest, in effect.
The Bottom Line
Requirements for getting a mortgage are stringent these days. Because jumbo mortgages are much more valuable and not backed by the government, borrowers must have considerable assets and a strong credit history. Still, there are signs that jumbos are becoming easier to obtain; certainly, the interest rates on them are coming into line with those of conventional mortgages.
You could contribute these low rates to the fact that jumbo mortgage borrowers are likely to have excellent credit and considerable assets. Also, bankers are eager to attract the business of high-net-worth individuals for a long-term product like a mortgage, since these borrowers may also become clients for other products and wealth management services the bank may offer.