A jumbo loan, also known as a jumbo mortgage, is a type of financing that exceeds the limits set by the Federal Housing Finance Agency (FHFA). So, unlike conventional mortgages, a jumbo loan is not eligible to 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 underwriting requirements and tax implications. These kinds of mortgages are gaining traction, especially as the housing market continues to recover following the Great Recession.
How Big Is a Jumbo Mortgage?
The value of a jumbo mortgage varies by state — and even county. The FHFA sets the conforming loan limit size for different areas on an annual basis, though it changes infrequently. As of October 2018, the limit was set at $453,100 for most of the country. That was a 6.8% increase from the 2017 value. For counties that have higher home values, the baseline limit was set at $679,650. Los Angeles County in California and Rockland County in New York State both have the higher baseline limit because of significantly higher home values.
The FHFA has a different set of provisions for areas outside the continental United States for loan limit calculations. So, the baseline limit for a jumbo loan in Alaska, Guam, Hawaii and the U.S. Virgin Islands as of 2018 is $679,650. That amount may actually be higher in counties that have higher home values as well.
Qualifying for a Jumbo Mortgage
If you have your sights set on a home that costs close to half a million dollars or more – and you don't have that much sitting in a bank account – you're probably going to require a jumbo mortgage. And if you’re trying to land one, you’ll face much more rigorous credit requirements than homeowners applying for a conventional loan. That’s because jumbo loans carry more credit risk for the lender since there is no guarantee by Fannie Mae or Freddie Mac. And, of course, the risk increases because there is more money involved.
Just like traditional mortgages, minimum requirements for a jumbo are increasingly stringent since 2008. To get approved, you’ll need a stellar credit score – 700 and above — and a very low debt-to-income (DTI) ratio. The DTI should be at least under 43% and preferably closer to 36%. Although they’re nonconforming mortgages, jumbos still must fall within the guidelines of what the Consumer Financial Protection Bureau considers a “qualified mortgage” — a lending system with standardized terms and rules, such as the 43% DTI.
You’ll need to prove you have accessible cash on hand to cover your payments, which are likely to be very high if you opt for a standard 30-year fixed-rate mortgage. Specific income levels and reserves depend on the size of the overall loan, but all borrowers need 30 days of pay stubs and W2 tax forms stretching back two years. If you're self-employed, the income requirements are greater: two years of tax returns and at least 60 days of current bank statements. The borrower also needs to provable liquid assets to qualify and cash reserves equal to six months of the mortgage payments. And all applicants have to show proper documentation on all other loans held and proof of ownership of non-liquid assets, like other real estate.
How much you can ultimately borrow depends, of course, on your assets, your credit score and the value of the property you're interested in buying. (For further information, see Too Much Debt for a Mortgage?)
Jumbo Loan Rates
On the bright side, while jumbo mortgages used to carry higher interest rates than conventional mortgages, the gap has been closing in recent years. Today, the average annual percentage rate (APR) for a jumbo mortgage is often par with conventional mortgages — and in some cases, actually lower. Wells Fargo charged an APR of 4.99% on a 30-year fixed rate conforming and government loan, versus 4.657% for the same term on a jumbo loan. This was was effective as of October 2018.
Even though the government-sponsored enterprises can't handle them, jumbo loans are often securitized by other financial institutions; since these securities carry more risk, they trade at a yield premium to conventional securitized mortgages. However, this spread has been reduced, with the interest rate of the loans themselves.
Down Payment on Jumbo Loans
On the even brighter side, down payment requirements have loosened over the same time period. In the past, jumbo mortgage lenders often required home buyers to put up 30% of the residence's purchase price (compared to 20% in conventional mortgages). Now, that figure has fallen as low as 10% to 15%. As with any mortgage, there can be various advantages to making a higher down payment – among them, to avoid the cost of private mortgage insurance. (For more, see Private Mortgage Insurance: Avoid It for These 6 Reasons.)
You could attribute all these low rates for interest and down payments to the fact that banks are generally very eager to find new customers for their jumbo loan packages. Jumbo mortgage borrowers are likely to be, or are on the road to becoming, the sort of high net worth individuals institutions love to sign up for long-term products. Such clients have an excellent credit history, plenty of assets and often need additional wealth management services. Plus, it's more practical for a bank to administer a single $2 million mortgage than 10 $200,000 loans.
Who Should Get a Jumbo Loan?
These mortgages are considered most appropriate for a segment of high-income earners who make between $250,000 and $500,000 a year. This segment is known as HENRY, an acronym for "high earners, not rich yet." Basically, these are people who generally make a lot of money but don't have millions in extra cash or other assets accumulated – yet.
While an individual in the HENRY segment may not have amassed the wealth to purchase an expensive new home with cash, such high-income individuals do usually have better credit scores and more extensively established credit histories than the average home buyer seeking a conventional mortgage loan for a lower amount. They also tend to have more solidly established retirement accounts. They have often been contributing for a longer period of time than lower-income earners.
The Tax Implications of a Jumbo Loan
Just because you may qualify for one of these loans doesn't mean you should take it. You certainly shouldn't if you are counting on it furnishing you with a substantial tax break, for example.
You’re probably aware that you can deduct any mortgage interest you paid for any given year from your taxes. But you probably never had to worry about the cap the IRS places on this deduction. You can deduct the 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
And even though interest rates are more in line with those of conventional mortgages, it still might behoove you to crunch numbers and compare terms, to see if taking out two smaller conforming loans, instead of one big jumbo, might prove better for your finances in the long haul.