In financial terms, a loan is an amount of money that is lent by an individual or an organization to another individual or an organization for different purposes ranging from profession to personal. Normally, the borrower pays an interest on top of the money he borrowed in order to make up for the loan.
Jumbo loans are a type of loans that exist in the United States of America. In US, Jumbo loans are the loans that exceed the conventional loan limits set by the FHFA. FHFA is the Federal Housing Finance Agency which controls procedures and standards related to housing and mortgages. Ordinarily, the loans and mortgages are purchased or guaranteed by the Federal National Mortgage Association also known as Fannie Mae and Federal Home Loan Mortgage Corporation also known as Freddie Mac. These two are large agencies that purchase most of the mortgages and loans from the banks and lenders in order to provide them with cash and liquidity for future purposes so they can continue their services. Hence Jumbo Loans are either not covered at all by Fannie Mae or Freddie Mac or covered only partially till the limits of conventional loan limits.
Jumbo loans exceed the normal loan limits which is why they are called jumbo loans. They are used for various purposes but mostly for financing luxurious properties and homes or normal homes that are available in highly competitive markets which skyrockets their prices. They also make more good investment later on. As Jumbo loans are unconventional loans, they come with extraordinary conditions and requirements to fulfill as well. They come with unique underwriting requirements as well as tax implications. Underwriting means the process of taking on risks that are financial for a fee. These risks are normally loans or insurances.
Normally, there are limits set on conventional loans, which are covered by Freddie Mac and Fannie Mae, hence the lender is secured and more willing to offer loans on slightly easier terms. In the case of Jumbo loans, it’s the opposite. Since neither of Freddie Mac or Fannie Mae would guarantee the loan, the lender is less willing to offer such a large amount of money and provides it on stricter terms.
Normally Jumbo Loans have higher interest rates as well but it’s not necessary. Sometimes the interests are lower as well. These interest rates can be fixed or adjustable as it depends on the lender and the borrower.
How a Jumbo loan works and what qualifies you for a jumbo loan?
Let’s say you want a home or a property north of half a million dollars and you don’t have that kind of money in your bank account, you’ll have to apply for a jumbo loan or mortgage. Because it’s an unguaranteed and uncovered loan by Freddie Mac or Fannie Mae, the terms on which the loan will be provided are much stricter and rigid than normal loans. As the loans are larger, they carry much more financial risk for the lender and the borrower himself since there are no guarantees by Freddie Mac or Fannie Mae. Naturally, because a much higher sum of money is involved, there’s a greater risk for everyone involved.
Ever since the great recession of 2008, the conditions and minimum requirements regarding jumbo loans as well as conventional loans have become incredibly rigid and precise. To be approved for a jumbo loan, an excellent credit score is a must. A credit score of 700 or more is considered appropriate for such causes. Another thing that you’ll need is a low debt-to-income (DTI) ratio. The DTI ratio that is considered appropriate is 43% and considered excellent if it’s closer or below 36%.
Although they’re nonconforming mortgages, meaning that they don’t fall under the conventional loans covered by agencies, they’re still required to meet the limits and guidelines of a qualified mortgage as described by Consumer Financial Protection Bureau. The description of a qualified mortgage by CFPB is a standardized definition of terms, conditions and rules such as the 43% DTI ratio.
You’ll need to have a lot of cash on hand to make sure you can cover payments and make sure the lender knows about how you can cover the payments. The payments are likely to be high since the money you are going to borrow is a large amount of money. Overall loans have other factors depending upon it like specific income levels and reserves. Though all borrowers require to have 30 days of pay stubs and W2 tax forms that cover more than the last two years. If you are self-employed, the requirements that needs to be fulfilled are larger as they require tax returns of two years as well as current bank statements of at least two months. These are to ensure that the person is indeed responsible, eligible and will be able to cover the payments. On top of all that, the borrower needs liquid assets that can be proved to quality for the jumbo loan or mortgage and cash reserves that cover at least six months of the payments of the mortgage. Besides this, the borrowers need to provide proper and appropriate documentations on all other loans (if any) held and proof of ownership of other non-liquid assets or other real estate if any.
So in short, to qualify for a jumbo loan, you need to have an excellent credit score of at least 700, a good debt-to-income (DTI) ratio of 43% or lower, then enough cash to ensure you can cover the mortgage payments for at least 6 months, tax returns of 2 years or more, bank statements for over the last two months and proper documentation of ownership of any other assets like real estate.
Are jumbo loans better or worse?
That question doesn’t have a simple answer. Since the government agencies aren’t involved, the terms and conditions are set by the lender and those terms and conditions are met by the borrower. If you are a borrower, it depends on the deal you’ve negotiated with the lender and how it turns out for you. So jumbo loans can be better than conventional loans if you have set comfortable terms that work out well for you or worse for you if the lender takes advantage of your situation and you don’t have other options except to get a jumbo loan through that same lender.
Jumbo loans against conventional?
Jumbo loans vs. conventional loans is a pretty straightforward story. Conventional loans are covered and guaranteed by Freddie Mac and Fannie Mac ensuring lenders their money as well as securing the mortgages so the future of lenders can continue while Jumbo loans are not covered or sometimes are partially covered by Freddie Mac and Fannie Mac. For loan amounts that don’t conform to the conventional loan limits, you have to acquire a jumbo loan. It’s simply because jumbo loans are applicable on price tags much higher than the ones covered by conventional loans. If you want to buy a particularly expensive or luxurious home, you will need a jumbo loan. While a conventional loan is for the average homebuyer who’s looking for an affordable home. Nothing special.
The interest rates of Jumbo loans are often higher than conventional loans as well but in recent times, the rates have been on par with conventional loans and in some states and cases, even lower than conventional loans thus making them more accessible and attractive. The average annual percentage rate (APR) for jumbo loans is on par with conventional loans. For referential purposes, Wells Fargo, charged an APR of 3.793% for a jumbo loan for a 30-year fixed rate jumbo loan while they charged 4.092% for a conventional loan on the same terms and conditions.
In the past, down payments were huge for jumbo loans as compared with conventional loans but fortunately that gap has been closed over the years as well and in fact reversed. Conventional loans have a down payment requirement of 20% of the whole purchase price while jumbo loans have a percentage in the range of 10 to 15. That is excellent. It used to be 30% of the whole purchase price but it has dropped and is even lower than conventional loans.
Why would you need a jumbo loan?
People often want to buy homes or properties that are expensive, luxurious or both. These properties could be used for living or for investment purposes. Let’s put it this way, you want to buy a home for about a million dollars but you only have about $300k to $400k but you know you can cover the rest of the money in the coming months. See, a million-dollar loan wouldn’t be covered by the conventional loan system and that’s where the jumbo loan comes in. Jumbo loans’ limit depends on your cash reserves, credit score, history, the mortgage’s loan-to-value ratio, size of the loan and DTI ratio. When you require a loan that doesn’t conform to the guidelines or limits of the conventional loans, you have to apply for a jumbo loan. Since these are not covered by the government, the terms and conditions are set entirely by the lender which sometimes makes it harder to acquire such loans or mortgages but most of the times, they cost less than conventional loan systems.
If you are a high earner but not rich yet, or you earn a handsome salary but you don’t have huge cash reserves, the jumbo loan is for you.
What is the maximum jumbo loan amount and the factors that determine the limit of the jumbo loan?
There is no fixed maximum amount for jumbo loans. Since the government or the governmental agencies are not involved in the process, the parties involved are the lender and the borrower. Since the lender can name his terms and those terms must be fulfilled for the loan to be approved, it depends on the lenders, the terms and the borrower. There are also certain factors that depend on the amount of the loan such as size of the required loan, the borrower’s credit score and history and a few more. They are mentioned.
These are the factors on which the jumbo loan’s limit depends:
- Size of the loan.
- Borrower’s credit score (FICO score)
- Borrower’s credit history
- Borrower’s cash reserves.
- Debt-to-income ratio.
- Mortgage’s loan-to-value ratio.
- The interest rate which is in some cases fixed or some cases adjustable.
Furthermore, the lender can put forward his own terms and conditions that must be fulfilled. These terms and conditions include the interest rate. The lenders can create their own approval criteria and will offer higher loans if the credit history, cash reserves and credit score is excellent as well as other factors.
What amount is considered as a jumbo loan?
There are certain limits set in the conventional loan system. These limits are set by the government as well as the lenders who loan the money. These loans are guaranteed and covered by the Freddie Mac and Fannie Mac agencies which buy the mortgages and loans from the banks and lenders in order to provide them with money and liquidity so that they can keep providing loans and mortgages to the vast population of the United States. Any amount that doesn’t conform to these limits, that amount is considered as a jumbo loan.
The conventional loan limits change every year varying state to state. The FHFA sets these limits on annual basis and different in every state. For example, as of 2020, the conventional loan limit was set to $548,250.00 for one unit dwelling in most of the country while in states or areas with higher home market values, the loan limit was set to $822,375 which is exactly 150% of the original amount that was $548,250.00. These apply for expensive areas like New York and Los Angeles as well as California. Now if you require a loan that exceeds these conventional loan limits, you will have to get a jumbo loan. A jumbo loan’s limits are not fixed. Rather the amount depends on certain factors which are already mentioned.
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