Jumbo loans may have a reputation as a somewhat exotic form of home financing, but in the right circumstances, they can be the perfect fit for you and for the property you plan to purchase. Here is an easy-to-understand overview of what you need to know about jumbo loans.
Two government sponsored enterprises (GSEs), namely Fannie Mae and Freddie Mac, accounted for more than 75% of new mortgage financing last year. They provide financing indirectly by purchasing mortgages from banks and other mortgage lenders that extend mortgage financing according to Fannie Mae and Freddie Mac’s underwriting guidelines. Since the sub-prime mortgage crisis of 2008, the Federal Housing Finance Agency (FHFA) has had the job of overseeing these two companies to insure they remain financially healthy and continue to support the home mortgage industry.
One of the FHFA’s numerous regulatory actions is to set maximum loan limits. The limit is currently $417,000. Loans under the loan limit are called conforming or conventional loans because they conform to the underwriting requirements and can be sold to Fannie Mae or Freddie Mac.
Conforming Jumbo Loans
In certain high cost markets, such as parts of California, New York, areas around Washington D.C., Alaska, Guam, and Hawaii, there are higher loan limits set by the FHFA. For example, limits go as high as $721,050 for the metropolitan Honolulu area. Loans above $417,000 but below the high cost market limit are known as conforming jumbo loans. These loans can also be sold to Fannie Mae or Freddie Mac.
Nonconforming Jumbo Loans
Many banks will extend mortgage financing to their most qualified customers beyond conforming jumbo loan limits. These loans usually charge higher interest rates and are held by banks “on the books” as a profitable investment. These loans are called nonconforming jumbo loans.
To protect themselves from interest rate fluctuation, most nonconforming jumbo loans are adjustable rate mortgages (ARMs). If interest rates go up, then the mortgage rate goes up. ARMs typically have a period of fixed interest followed by a periodic adjustment based on some interest rate benchmark. A 5/1 ARM, for example, will have a fixed rate of interest for 5 years followed by an adjustment every 1 year after that.
Interest only jumbo loans are also available, as are jumbo loans for investment properties and second homes.
Jumbo Loan Criteria
To secure a nonconforming jumbo loan you must meet the following criteria.
- 20% down payment.
- Credit score of 720 or higher.
- Your monthly payments, including principal, interest, taxes and insurance (PITI) cannot exceed 38% of your pre-tax income.
Where To Get a Jumbo Loan
Because nonconforming jumbo loans are investments held by banks, they are not required to meet underwriting criteria for resale to Fannie Mae or Freddie Mac. This flexibility creates a wide variety of loan products.
Some banks only make jumbo loans for principal residences, while others will provide them for investment properties and second homes. Some banks will reward good customers that have large deposits or investments with the bank with lower interest rates or lower down payment requirements. Other lenders will allow you to cover up to half of the 20% down payment with a higher rate second mortgage. The list goes on.
Perhaps more than any other loan product, when it comes to jumbo loans, it pays to shop around.