A home is a big purchase. The more you know, the easier it will be to understand what you're getting into. If you're buying a more expensive home, you'll likely need to use a jumbo loan. These loans help borrowers who want to get a mortgage amount over conforming lending limits.
If you're not sure what a jumbo loan is or don't understand some of the terms you've come across, don't worry. Here, we break down some of the most common terms for jumbo mortgages.
Jumbo mortgage/jumbo loan
When a lender provides a loan, that loan is often purchased by Fannie Mae or Freddie Mac. These organizations then sell the mortgages to investors which helps stabilize the mortgage market. In order to minimize the risk of these purchases, the Federal Housing Finance Agency (FHFA) has set limits for the amount of these mortgages. Any loan that falls above the federal maximum is considered a jumbo loan.
Because jumbo loans carry a bigger risk to lenders, they typically require stricter lending requirements. This includes:
- Higher credit score
- Higher reserves
- Larger down payment
- Potentially higher interest rates
Lenders offer different financing rates for different types of loans. This is how much interest you'll pay over the life of your jumbo loan. While these rates stay pretty consistent across the industry, each lender can set their own rates. Because these loans carry a higher risk to the lender, they can sometimes have a higher interest rate. It ultimately depends on the lender and the market conditions. But lenders that provide jumbo mortgages usually keep their rates competitive.
Non-conforming loans are mortgage loans that do not fall within the allowable loan limits for Fannie Mae and Freddie Mac. These loans are not backed by the federal government and are considered a higher risk to lenders.
While loan limit is a factor used to determine whether a mortgage is a conforming loan, other considerations include the borrower's credit score and down payment. All jumbo loans are non-conforming loans because they fall above the maximum FHFA lending amount.
Lenders offer many different types of loans to potential borrowers. Some of these are backed by government agencies, and some are not. Conventional loans are loans that, regardless of loan limit, are not backed by the federal government. This means all jumbo loans are conventional loans. However, not all conventional loans are jumbo loans.
Mortgage lenders set lending limits to reduce risk. Depending on the type of loan, these limits may be set by the individual lender or by a government agency. While an agency may set a maximum loan limit, the lender may reduce the amount of the loan they'll approve based on the borrower's qualifications. This includes:
- Credit score
- Employment history
- Debt to Income
- Loan to Value
When you apply for a loan, your lender will consider different variables to determine whether you qualify for a loan. If you're looking for a jumbo loan, the bank will likely require you to have a certain amount of money in the bank after the closing of the loan, known as reserves.
Think of reserves as your lender's determination that you have sufficient money to pay your loan and costs subsequent to closing. The amount your bank requires you to have depends on the amount of your loan, the size of your down payment and how much of a risk your lender considers the loan. Most lenders want to see a higher amount of reserves for jumbo loans.
Before you purchase a home, it's important for you and your lender to know how much the home is worth. An appraisal helps ensure you don't pay too much for a home.
Appraisers look at many different things to give you an estimate of what a house is worth. These include:
- The home's condition: Is the home structurally sound? Are there any major defects? Think of things like the condition of the roof, foundation and flooring.
- Updates: A home with newer appliances and modern fixtures is worth more than one that hasn't been updated in years. This goes beyond the home's aesthetics. For older houses, the appraiser will also consider if the heating, electrical and plumbing systems have been modified since their initial installation.
- Square footage: The size of a home doesn't automatically make it more valuable than another home. However, when comparing two similar homes, size does play a factor.
- Neighborhood comps: One of the biggest things your appraiser will look at is what other homes have recently sold for in the area. Typically, the appraisal will include a list of nearby homes of comparable size and condition, how long they were on the market and the final selling price.
Appraisal values can vary. For this reason, jumbo loans may require two separate appraisals. It's important to consider this when you apply for a home because appraisals generally fall under the buyer's share of closing costs.
Liquid assets are any assets you can quickly exchange for cash. Though most lenders prefer cash as the sole source of cash reserves, some may consider a combination of cash and other liquid assets. Items that your lender may consider include:
- Checking, savings & CDs
- Mutual funds
- Treasury bonds
- Exchange-traded funds (ETFs)
It's important to note, real estate is not a liquid asset as it could take months to sell. Generally, borrowers with more liquid assets will have an easier time qualifying for a jumbo mortgage.
In order to determine if a buyer can repay, lenders look at the buyer's debt-to-income ratio (DTI). In its simplest form, this is the amount of money you owe versus the amount of money you bring in. Your lender calculates your debt-to-income ratio by looking at your total monthly debt payments compared to your total gross monthly income. If there are joint borrowers, the combined amount of debt versus combined income will be considered.
If you're applying for a jumbo loan, your lender will likely want a lower DTI. If your DTI is not as favorable, your lender may weigh it against your overall creditworthiness.
Another way lenders can minimize their risk is to make sure they don't approve loans that are more than a certain percentage of what the home is worth. This is where the appraisal comes in.
To calculate loan-to-value (LTV) you need to take the amount of your loan and divide it by the lesser of the sales price or appraised value. The number your lender is looking for can vary, but in most cases, you can expect LTV restrictions on jumbo loans to be higher than with a guaranteed loan.
Buying a home doesn't have to be confusing. This is an exciting time in your life and knowing the right terms can help you be a confident homebuyer. If you have questions or want to learn more about jumbo loans, talk with a Home Lending Advisor.