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A jumbo loan, or jumbo mortgage, is a home loan for an amount that exceeds the "conforming loan limit" set on mortgages eligible for purchase by Fannie Mae and Freddie Mac, the government-sponsored enterprises (GSEs) that ultimately buy and administer most single-family-home mortgages in the U.S.
The Difference Between Jumbo and Conforming Loans
For 2019, in most of the continental U.S., the conforming loan limit is $484,350. In Alaska, Hawaii, certain U.S. territories, and specific counties in the lower 48 states where home prices are exceptionally high, the limit can be as much as $726,525, or 150% of the national median. You can check the conforming loan limit for all U.S. counties at the FHFA website.
A mortgage for an amount greater than the local conforming limit is considered a jumbo loan.
Jumbo loans typically come with strict credit requirements and an even more rigorous review of applicant finances than conventional mortgages.
How Does a Jumbo Loan Work?
To understand how a jumbo loan works, it's helpful to understand the purpose of "conforming loans," which have a lending limit that's exceeded by jumbo loans: The Federal Housing Finance Agency (FHFA), which regulates Fannie Mae and Freddie Mac, was created during the Great Depression to make sure mortgage lenders have sufficient cash available to lend to Americans who want to buy a home. To that end, the FHFA authorizes Fannie and Freddie to purchase loans from banks, credit unions and other lenders, but only if those loans meet specific criteria aimed at protecting the GSEs from loss in case borrowers fail to repay the loans. One of those criteria is that the mortgages cannot exceed the conforming loan limit, which the FHFA sets annually for each county in the U.S.
Fannie Mae and Freddie Mac combine batches of conforming loans into financial instruments called mortgage backed securities (MBS) that investors buy and sell in public markets, much like stocks. The GSEs use the proceeds from MBS sales to buy and securitize even more mortgages. Lenders use money from the sales of loans to Fannie and Freddie to offer more mortgages, and the process continues.
The ability to sell a mortgage to Fannie Mae or Freddie Mac is a kind of safety net or guarantee for the lender, so when considering applications for jumbo loans, financial institutions typically are extra cautious in their efforts to verify applicants' ability to repay the loan.
Credit Score and Requirements Needed for a Jumbo Loan
The applicant-vetting process on jumbo loans may vary by lender (and applicant), but requirements over and above those for conventional mortgages may include:
- Higher credit scores. Many lenders require a FICO® Score☉ of 720 or better for many jumbo loans, and typically will accept no score lower than 660, whereas lenders may accept scores as low as 600 for conforming mortgages.
- Larger down payments. While lenders may approve conventional mortgages with down payments as low as 5% with the inclusion of private mortgage insurance (PMI), jumbo loan issuers typically require down payments of 20% or even as high as 30%. Down payments greater than 20% preclude the need for PMI, but in the rare instance where a lender accepts a down payment lower than 20%, PMI may be required on a jumbo loan just as it is on conforming mortgage loans.
- Greater cash flow. Mortgage lenders typically look for a debt-to-income (DTI) ratio—calculated by dividing monthly debt payments by gross monthly income—of no more than 36% when issuing jumbo mortgage loans. In contrast, DTIs as high as 50% are acceptable on some conforming mortgages.
- Additional assets. As a safeguard against the possibility of missed payments on jumbo loans, lenders often require applicants to prove they have access to savings or other liquid assets sufficient to cover as much as one year of loan payments.
- Higher interest rates. The additional risk associated with non-conforming loans typically leads lenders to bump up interest by 1 or 2 percentage points on jumbo loans compared with the prevailing rates on conventional loans.
- Additional appraisals. In addition to the standard property appraisal required for any mortgage loan, jumbo lenders may require a "second opinion" appraisal to confirm the property's market value. Because properties subject to jumbo loans are often large and unusual in comparison with neighboring properties, each appraisal is likely to be more expensive than one on a more traditional property.
- Higher closing costs. To help cover the cost of the more extensive verification process required for jumbo loans, lenders typically charge a higher percentage of the purchase price (i.e., more "points") as a loan origination costs.
When Does It Make Sense to Get a Jumbo Loan?
If you want to buy a luxury home, or one with amenities that make it significantly more expensive than the average home in your community or county, a jumbo loan may be your only option for financing the purchase. Applying for a jumbo loan only makes sense if you have the financial resources needed to pass the rigorous qualification process, including a credit score of about 700 or better and sufficient liquid assets to cover a down payment of 20% or more, origination fees, appraisal(s) and at least six months of payments on the loan.
When Should Jumbo Loans Be Avoided?
You may want to avoid a jumbo loan if you doubt your ability to meet its stiff qualification requirements. In addition, if you feel you may need to resell the property quickly at some point in the future, you may want to consider how energetic the local real estate market is. If the market is slow, or if the property is vastly more expensive than most neighboring properties, it may prove difficult to resell. Even in vigorous markets, potential buyers will likely be subject to the same lengthy mortgage-vetting process you'd have to go through as a buyer, and that can lengthen the amount of time required to complete the sale.
Qualifying for a jumbo mortgage can be a daunting process, and the loan will likely be costly in terms of interest rates and fees even for applicants with very good credit. If your sights are set on an exceptionally expensive property, and you have the means to qualify, a jumbo loan may be the best option for financing your dream home.