They say that bigger is better. And that adage may be true with respect to jumbo mortgage loans. With a jumbo mortgage, you generally get a bigger home, bigger debt balance, and bigger monthly payment.
But If you play your cards right, you may also get a flexible financial planning tool that helps you manage taxes, allocate cash, and maximize investment returns.
Under current tax law, you can deduct mortgage interest on up to $1 million of home acquisition debt. Exploiting that cap can produce huge tax benefits. A $1 million, 30-year mortgage at 6.5 percent can produce tax savings in excess of $23,000 in the first year, assuming federal and state tax rates of 25 percent and 8 percent, respectively. That's a sizeable deduction for any tax planner.
Cashing in on investment returns
When you have a healthy personal balance sheet, you tend to manage your investment returns carefully. Naturally, your choice of mortgage plays a role in this effort. Mortgage debt is one of the least expensive sources of funds. In fact, borrowing to buy a home could cost you less than paying cash for it. This happens when the after-tax mortgage rate is lower than the after-tax yield earned on your invested cash.
Going back to the $1 million mortgage described above, the after-tax rate on that loan works out to about 4.5 percent. Say, for example, that you're earning 6 percent after tax on your invested cash. In such a scenario, you can see how it costs less to borrow the money for 4.5 percent than to give up 6 percent to pay cash.
Further, you might prefer an interest-only jumbo mortgage for similar reasons. Say that the monthly payment on an interest-only jumbo is $2,000 lower than the fixed-rate payment. In this scenario, you may want to deploy that $2,000 in a high-yield investment vehicle. You wouldn't build any equity in your home, but you could generate a better yield elsewhere.
To pay off or not
If you're buying the home as a financial planning strategy, you may not care about paying it off. The same holds true if you intend to live in it for a few years and then move on. In those situations, an interest-only jumbo spares you from paying down principal and minimizes your monthly living expenses.
On the other hand, a luxury home might be your ultimate reward for a lifetime of hard work. If you want to retire in this home, then you'll have to pay for it. A shorter loan life is beneficial because it minimizes your total interest costs. However, shorter mortgages also equate to much higher payments. Talk to your financial advisor about balancing tax and investment considerations with your monthly principal payments.
Credit score hurdle
The financial strategies associated with jumbo mortgages are only an option when you have a solid credit score and balance sheet. While each lender varies, most will require a credit score in the mid-to-high 600s for any type of jumbo. The requirement for an interest-only jumbo will be closer to 700.
At the end of the day, bigger is better when it improves your financial flexibility. Jumbo mortgages aren't suitable for everyone, but they can be handy financial tools for those who have the money, income, and credit score.