What You Need to Know About Jumbo Loans
When borrowing money in the form of a mortgage to buy a home, there are many mortgage choices. However, many of those mortgage choices have maximum loan amounts that limit the size of a mortgage to a particular amount. This is where a jumbo loan comes into play. A jumbo loan is a mortgage that has (technically) no upper limit as to the amount of the money to be loaned in the form of a mortgage.
However, jumbo loans have different conditions than traditional loans, which means home buyers may need to adjust their financial strategy to meet the additional requirements of their lender. An approval on a jumbo loan used to be far more difficult to obtain than it is today but that doesn't mean it's easy to be approved for one. Before buyers begin their application process, they need to keep both the perks and the pitfalls in mind of the jumbo loan.
How Jumbo Loans Work
The term 'jumbo loan' refers to larger loans, usually meant for luxury properties. Jumbo loans set their rules and regulations based on the neighborhood in which the property is located. For example, the maximum amount (conforming limit) for most of the traditional conventional loans guaranteed by Freddie Mac or Fannie Mae is $453,100. Therefore, most would believe that the minimum amount for a jumbo loan is $453,100, however, this amount actually varies from neighborhood to neighborhood. The jumbo loan minimum in Kansas City could be $453,100, but the jumbo loan minimum in Beverly Hills could be as high as $679,500. The limits will rise and fall based on everything from the local economy to the most recent property appraisals. Jumbo loans remain largely unregulated, meaning the lender is assuming responsibility in the case of default.
Who Should Apply for a Jumbo Loan
Interest rates for a jumbo loan have historically been higher than those of conventional loan due to fewer regulations and the lack of governmental agency guarantees. However, recent changes have brought interest rates closer (on average) to those of conventional loans. This is because the people who apply tend to be those with extremely low debt-to-income ratios coupled with equally high credit scores. Applicants will need to be ready to wait for approval though as the underwriting process becomes even more crucial for approval.
Buyers may be subjected to several underwriting reviews prior to the final decision. Lenders are looking for anything in the buyer's history that may signal risk, so they don't have to handle a potential default. And while every lender has their own version of minimum criteria, their biggest concern is confirming a buyer has enough savings and assets to cover the costs of the mortgage even if the buyer goes through financial trouble.
Jumbo Down Payment Basics
The jumbo loan minimum down payment was recently relaxed to allow more people the chance to own San Pedro luxury properties. However, even considering the changes, many lenders won't accept anything less than 15% of the total cost of the home. As with conventional loans, the ideal number to hit is 20% equity in the home. If the buyer only puts down 10 – 15%, they'll need to pay for Private Mortgage Insurance (PMI) until they hit the required 20%. This special insurance policy taken out by the lender and paid for by the homeowner can add up to 1% of the cost of the home every year. Considering that buyers will largely pay for interest the first few months, buyers should aim to put down as much as possible on a jumbo loan.
ARM Vs. Fixed Interest Rates
Adjustable-rate mortgages are typically not recommended for jumbo loans. This is because even a small market uptick can spell huge costs for a large loan. Instead, applicants should consider 15 to 20 year fixed-rate loans so they can plan their budgets and put more of the payment toward equity over interest. Buyers searching in particularly popular markets, such as San Francisco or New York City, have a better chance of finding small lenders who offer better interest rates than those of the major banks.
Jumbo loan applicants may have the option of taking out two separate mortgages on the same home. This strategy is recommended for those who want to diversify their portfolio by investing in other markets. In this case, the buyer takes out two loans based on the balance of the 20% down payment. If a buyer puts down 15% on a $500,000 loan, they could take out a second loan for the remaining 5% (or $25,000). A buyer would then have two separate loans out for both the balance of the home and the balance of the down payment remainder. Buyers should only do this if they intend to pay off the second loan as quickly as possible. Interest rates on the second mortgage will be far more than those on the primary balance.
Jumbo loans are an excellent option for buyers who want to take advantage of the luxury neighborhoods of an area. Higher priced homes usually see higher rates of appreciation than their more affordable counterparts. It can be a risk to take out a jumbo loan, but the advantages may far outweigh the disadvantages if the buyer knows how to approach the application process.