What is the difference between a conforming and a jumbo loan? If you are looking to buy a house that costs more than half a million dollars, this is a very important question.
When you require a loan far greater than the average, the requirements for getting a mortgage become stiffer, you have to be prepared to offer more information, and you will likely pay more for your loan.
Read on to find out what you need to know about jumbo loans.
The main difference is the size of the loan. Conforming loans are capped at a specific dollar amount. Beyond this threshold, jumbo loans take over.
What is the threshold for a jumbo loan? In most counties, this cap is set at $548,250, though it goes up to $822,375 or even more in high-cost areas. Jumbo loans are issued for dollar amounts above this cap and are considered non-conforming loans.
Unlike conforming loans, jumbo loans are not backed by Fannie Mae and Freddie Mac. Plus, the lender is loaning a higher dollar amount to a single borrower. Both of these factors make these loans riskier for lenders.
Jumbo loans are typically aimed at people who earn a lot of money but are not (yet) rich enough to buy a house outright. Though they carry additional risk, big loans are less expensive for lenders to manage. It takes less work to issue one $2.5 million dollar loan than ten $250,000 loans.
Plus, individuals in this higher spending category are often interested in other investments and wealth management services. This gives the financial institution the opportunity to sell them additional financial products.
Because of the extra risk, jumbo loans are harder to qualify for as lenders have stricter requirements.
To qualify for the best home mortgage rates, borrowers generally need a credit score of at least 680-700. However, you can be eligible for a loan with a score as low as 580. You’ll just pay a little more in interest.
Jumbo loan lenders typically do not have this same flexibility. The minimum credit score for these loans is usually 700 or even 720.
The debt-to-income ratio (DTI) is another key component of your financial profile. This ratio measures how much debt you have compared to your income. This is calculated by dividing your typical monthly income by your usual monthly debt payments.
For conforming loans, lenders want a ratio at least as low as 43%. While you may be accepted for a jumbo loan with a DTI of 43%, many lenders prefer this number to be even lower.
However, depending on the lender you’re working with, there may be some flexibility. For example, some lenders may be willing to bend the DTI requirements if you have ample cash reserves, though most still top out at about 45% DTI.
Lenders like to see that jumbo loan applicants have ample cash reserves. How much is ample? These reserves often need to equal up to a year of mortgage payments.
You have to provide a lot of information to apply for a smaller conventional loan. But the paperwork really piles up when you’re talking about jumbo loans.
Be prepared to show everything from W-2s, 1099s, tax returns, bank statements, investment information, and more. If you work for yourself, expect the financial requirements to be even stricter.
Because of the extra work required to qualify borrowers for jumbo loans, be aware that your closing costs will be higher than those for smaller loans.
You might assume you’ll have to pay higher interest rates on jumbo loans. After all, lenders are taking on a higher risk, so they may be looking for a higher reward. It is true that some jumbo loans come with higher interest rates than smaller conventional loans.
However, this isn’t always the case. Depending on your financial situation, you may find lenders willing to offer similar rates or even slightly lower ones than on conforming loans.
Be prepared for a hefty down payment if you want to take out a jumbo loan. While many loan programs accept 5% and even 3 or 3.5% down payments, most jumbo loans still require at least 20% down. This helps to offset the risk of the loan.
You can count yourself lucky, though. In the not-too-distant past, lenders wanted at least 30% down on jumbo loans!
If you have strong financials, you may find a lender willing to go down to 15% or even 10%, so be sure to shop around.
What is the Loan-to-Value (LTV) ratio? You find the ratio by dividing the home’s appraised value by the loan amount. For example, if you purchase a home for $100,000 and get a loan for $90,000, your LTV is 90%.
You may be surprised to learn that the maximum loan-to-value on jumbo loans can be as much as 95%. FHA programs with extremely tight requirements will allow borrowers to finance up to 95% of the home’s value.
However, there is generally a loan amount limit, such as $2 million. Borrowers may need even higher credit scores and other financial requirements to qualify.
We hope we have helped you understand the difference between a conforming and jumbo loan. There are many factors to consider when taking out any home mortgage, but you have to be even more cautious when dealing with these high dollar amounts.
Your lender will help ensure that you don’t get in over your head, but be sure to do your own research as well. Happy house hunting!