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If you're looking to buy an expensive home, a jumbo mortgage may be your best way to do it. With a jumbo loan, you get access to additional funds you can use to finance the purchase of a property to live in yourself or rent out as an investment. But while jumbo mortgages can be beneficial in their own right, there are certain drawbacks to taking one out. Here, we'll review some jumbo loan basics and let you know what pitfalls to look out for.
What is a jumbo mortgage?
Each year, the Federal Housing Finance Agency sets a limit for conforming mortgage loans -- those adhering to the standards dictated by Fannie Mae and Freddie Mac, the government-sponsored enterprises that buy most home loans and make them available to investors. When you borrow a sum that exceeds the conforming loan limit, you move into jumbo loan territory.
For the bulk of the U.S., the maximum conforming loan limit for one-unit properties is currently $510,400. Certain high-cost areas, including Alaska, Hawaii, Guam, and the U.S. Virgin Islands, however, are subject to higher conforming loan limits of $765,600 for one-unit properties.
Jumbo mortgages are home loans that exceed conforming loan limits. There are technically no limits associated with jumbo loans; jumbo mortgage lenders can determine how much financing they're willing to give out on a case-by-case basis.
One thing that's important to know about jumbo loans is that unlike conforming loans, Fannie Mae and Freddie Mac won't guarantee them. This means that if you take out a jumbo loan and default on your payments, your lender could face serious losses.
Qualifying for a jumbo mortgage
Because jumbo loans aren't backed by Fannie Mae and Freddie Mac, lenders typically impose stricter guidelines to qualify for them. And that makes sense -- jumbo mortgage lenders need to minimize their risk by ensuring that their borrowers are financially capable of keeping up with their housing debt.
To qualify for a jumbo mortgage, you'll generally need:
- Great credit
- High income
- A large amount of cash reserves
You can generally qualify for a conforming home loan with a credit score in the 500s, though in that situation, you may not be eligible for a particularly favorable rate. But if your credit score is anywhere in the 500 to 600 range, you can essentially forget about getting approved for a jumbo mortgage. Usually, you'll need a much higher credit score -- one well above 700 -- to snag a jumbo mortgage. In some limited cases, you might get one with a score in the upper 600s.
You'll need a reasonably high income to get approved for a jumbo mortgage, as well. There's no specific dollar amount you should aim for in this regard. Rather, you need to earn enough money to have a very low debt-to-income ratio. This ratio measures your outstanding monthly debt obligations relative to your earnings. The higher it is, the more financially stretched thin you're apt to be, and so when you're borrowing a huge chunk of money to finance a home, your lender needs to be sure that you have the ability to keep up with your payments.
Finally, you'll usually need to have a sizable amount of cash on hand to get a jumbo mortgage, because lenders often require a 20% down payment on your home's purchase price.
Now you may be thinking: "But isn't 20% the convention anyway?" It's true that you're best off putting down 20% on a conforming home loan to avoid getting hit with private mortgage insurance, which is an extra premium you pay to buy your lender protection against you defaulting on your payments.
But while you can often qualify for a conforming loan without a 20% down payment, if you don't have that 20% on hand, the option to take out a jumbo mortgage may be off the table (not always, though -- some lenders may accept a lower down payment under limited circumstances).
Drawbacks of a jumbo mortgage
Taking out a jumbo mortgage is a good way to open the door to buying a pricier property you can't pay for outright. But there are some definite drawbacks to going this route.
1. Higher interest rates
As mentioned earlier, jumbo mortgages are considered riskier than conforming mortgages because they're not guaranteed by Fannie Mae and Freddie Mac. As such, lenders generally want more upside in return for giving them out, which means jumbo mortgage rates are generally higher than conforming loan rates. The result? You pay even more for your home.
2. Tying up your money in a down payment
You'll usually need to put down 20% of your home's purchase price when taking out a jumbo loan. The result? You're left with fewer liquid assets, which can be problematic on several levels.
The more money you're forced to sink into your home, the less you'll have on hand to invest elsewhere, whether in stocks, bonds, or other real estate. Furthermore, property is generally considered a relatively illiquid investment, because selling a home takes time. It can also cost a lot of money, and even if you're able to sell in a reasonable timeframe, you may not recoup your initial investment. As such, you may find that forking over a huge down payment limits you financially, or worse yet, leaves you cash-strapped.
3. Higher closing costs
Jumbo mortgages often come with higher closing costs than conforming mortgages. For example, it's not uncommon for jumbo mortgage lenders to require an extra appraisal on homes needing jumbo financing to ensure that their values are high enough to support that level of borrowing. (A jumbo mortgage lender doesn't want to give out an $800,000 loan for a property that may, in reality, only be worth $750,000.) But the cost of that added appraisal could easily be passed on to you, the borrower, at closing, thereby making your home even more expensive.
Should you take out a jumbo mortgage?
In many cases, limiting yourself to a conforming loan is a safer bet than taking out a jumbo mortgage, not to mention an easier path to take, and the following table illustrates why:
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