Jumbo Mortgages Explained
As the name implies, a jumbo mortgage is one that is larger than your usual home loan. However, depending on the area where you're buying a home, you may find that you need a jumbo mortgage for even a modest house.
These days, the term jumbo mortgage can be slightly misleading. While "jumbo" may conjure up images of super-sized country estates and oversized Hollywood mansions, even an unassuming house in the suburbs can require a jumbo mortgage if you're purchasing in a high-priced neighborhood.
Read on to find learn more about jumbo mortgages and why you may need one if you can afford it!
What is a Jumbo Mortgage?
Basically, a jumbo loan is any mortgage that exceeds the conforming limits set by Fannie Mae and Freddie Mac. This is $647,200 for a single-family home in most of the U.S. However, in certain high-cost areas of the lower 48 the conforming loan limit can go as high as $970,800. Mortgages in this range are called conforming jumbos.
High-cost areas include many of the nation's major metropolitan areas, including New York City, Los Angeles, San Francisco and Washington, the nation' s capital. Outside the continental U.S., conforming jumbos for a single-family home can be higher than $970,800 in high-cost areas of Alaska, Hawaii, Guam, and the U.S. Virgin Islands.
Anything above the local conforming limit is simply called a jumbo loan, without qualifiers.
How are they different from other loans?
Jumbo loans aren't eligible for backing by Fannie Mae or Freddie Mac, nor by any other government entity. That means they aren't guaranteed in the event of default, making them a riskier prospect than lower-cost, conforming mortgages.
That also makes it more difficult to package jumbo loans into mortgage securities for sale to investors. Lenders like to do that with mortgages because it allows them to earn their money on originating new loans, rather than on interest payments, and provides them with fresh capital to issue more loans.
With jumbo loans, lenders often keep them on their books and make their money off the interest, which is less profitable. As a result, jumbo loans traditionally charge higher interest rates and have larger down payment requirements, often 20-30 percent.
You also may find that lenders are much stricter about documenting a borrower's income and other financial data than on lower-priced loans.
Historically, the interest rate on a jumbo loan typically runs anywhere from one-half to a full percentage point higher than on a comparable conforming mortgage. But these are not typical times.
Jumbo rates now lower than conforming
Jumbo rates are often competitive and could be lower than conforming rates. Given that jumbos don't have the backing of Fannie Mae and Freddie Mac, that's a historical anomaly. So what gives?
The answer lies in one other key fact about jumbo loans. The borrowers who obtain them are, without exception, financially well-off. And that makes them attractive clients for bankers.
Of course, well-off clients are always attractive to bankers. What's different today is that the stricter lending guidelines imposed by Fannie and Freddie in the wake of the crash is making it more difficult for lenders to originate conforming loans. Fannie and Freddie are also charging higher fees for guaranteeing those loans, which are passed along to borrowers.
Jumbo loan borrowers also tend have substantial financial assets and post hefty down payments, which make such loans relatively safe compared to the uncertain economic circumstances of many middle-class borrowers today.
On top of that, banks are using jumbo mortgages as a way to establish business relationships with well-off clients so they can sell them other financial services, such as checking accounts, auto loans, investment services and the like. So they're treating jumbo loans a bit like a loss leader.
To be sure, this is likely to be a temporary situation and that jumbo loans will again be more costly than conforming ones once the housing market regains its equilibrium.
Consider a jumbo ARM
Many conforming loan borrowers are leery of adjustable-rate mortgages (ARMs) these days, associating them with the large numbers of foreclosures that occurred when homeowners could no longer afford their monthly payments after their rates adjusted higher. But for jumbo loan borrowers, an ARM can be the ideal product.
The initial rate on an ARM is considerably lower than on a comparable 30-year fixed-rate mortgage. That means that a well-off borrower who intends to pay off their mortgage quickly can pay more toward principal and less in interest before the rate resets a few years down the road.
On the other hand, borrowers who don't want to tie up a lot of money in an expensive home often use ARMs to minimize their monthly payments. If the rate does reset higher in 5-10 years, they can afford the higher payments if need be, or even refinance into a new ARM at an attractive rate.
ARMs also work well for borrowers who expect to move every few years, as is often the case with executives building their careers and climbing the corporate ladder. There's no need to lock in a rate for 30 years if you're going to be moving in five.
If you can stomach it, a jumbo ARM will have a much lower initial rate than a fixed rate jumbo mortgage.
Depending on where you're looking and the type of home you're seeking these days, you could be surprised to discover that you'll need a jumbo mortgage to finance it. But if you can afford it, there's rarely been a better time to be financing a higher-priced home than in today's market.
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