Breaking Down Jumbo Loans: How They Work and Who They Benefit

May 18, 20237 min read
Breaking Down Jumbo Loans: How They Work and Who They Benefit
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Key Takeaways

  • Also called a jumbo mortgage, a jumbo loan is a type of financing that exceeds limits put in place by the Federal Housing Finance Agency.
  • Compared to a conventional loan, those seeking a jumbo loan must generally meet more stringent credit requirements.
  • Down payments for jumbo loans are usually around 10% to 15% of the overall purchase price.

Real estate investors and those seeking to enter the market may, sooner or later, have a scenario in which a “jumbo loan” is part. That is, if they need more financing than what the federal government allows. But what does the loan entail? Here is, breaking down jumbo loans: how they work and who they benefit.

What is a Jumbo Loan?

Also called a jumbo mortgage or non-conforming conventional mortgage, a jumbo loan is a type of financing that exceeds limits established by the Federal Housing Finance Agency (FHFA).

In other words, a jumbo loan is used to finance real estate – usually luxury — that costs too much for a conventional conforming loan. Properties that cost more than the conforming loan cap require a jumbo loan. 

Such a loan, unlike conventional mortgages, is ineligible for purchase or guarantee, and may not be securitized by Freddie Mac or Freddie Mac. This kind of loan also has special underwriting requisites and IRS implications.

While jumbos are non-conforming mortgages, they still must follow Consumer Financial Protection Bureau guidelines regarding what is deemed a qualified mortgage.  

How Does a Jumbo Loan Work?

There are key elements involved in jumbo loans and the process for taking them out, including:

  1. Credit score considerations. Compared to a conventional loan, those seeking a jumbo loan must meet more stringent credit requirements. Namely, borrowers must have top-notch credit and a markedly low debt-to-income ratio – one’s monthly debt payments divided by their gross monthly income. Such rigorous credit requirements are because such loans carry more lender risk. Why? Because more money is involved and there are no guarantees by Freddie Mac or Freddie Mae.
  2. Income considerations. The borrower must show that they have access to cash to cover mortgage payments, which can be lofty if the mortgage is a 30-year fixed rate. The loan size will determine income, and reserves levels required. However, all borrowers must provide W-2 tax forms going back two years, as well as a month of pay stubs. Self-employed people face even tighter income requirements: a minimum of 60 days of current bank statements and two years of tax returns. Further, the borrower also must possess liquid assets and enough cash to cover six to 12 months of mortgage payments. All applicants must properly document any other loans held.  
  3. Interest rates and terms. For a jumbo mortgage, the average yearly percentage rate is typically similar to the rate offered by conventional mortgages, and in some cases, even lower.  
  4. Loan amount thresholds. The most one can borrow varies by state and sometimes even by county. For 2023, the maximum for such a loan is $726,200 for most of the country – a $79,000 hike over last year. Counties nationwide with higher incomes have a set baseline of $1,089.300, equal to 150% of $726,200. Note that for areas outside the continental United States – Alaska, Hawaii, Guam, and the U.S. Virgin Islands – the baseline for this year is $1,089,300 as well.  
  5. Down payment requirements. Down payments for jumbo loans are usually around 10% to 15% of the overall purchase price.

Benefits and Considerations of a Jumbo Loan

As with most anything else in the investment space, there are advantages and considerations when it comes to jumbo loans, including:

  • Access to higher-priced properties. With a jumbo loan, a person can buy more house. In other words, if the interest is in a house that costs at least $500,000, a jumbo loan can make it happen. How much one can borrow will ultimately depend on one’s assets, credit score, and the value of the property in which they are interested, however.
  • Flexible financing options.  Sans restrictions from Freddie Mac, Freddie Mae, or wholesalers, jumbo lenders can be more flexible when it comes to their offerings. 
  • Potential tax advantages. For new mortgage debt secured after 2017, the most one can deduct is $750,000 ($375,000 if married but filing separately).
  • Higher borrowing costs. Before pursuing a jumbo loan, potential borrowers must be sure to factor in the higher costs that will be required with a jumbo, such as a possible second home appraisal.
  • Additional underwriting requirements. Do note that, because jumbo loans are larger and riskier, underwriting criteria for these loans are more stringent. Further, because of the extra qualifying steps, there will likely be higher costs upon closing. 

Jumbo Loan vs. Conventional Loan

The primary difference between a jumbo loan and a conforming loan is the loan size. Generally, low down payments are relatively common with conforming loans. By contrast, jumbo loans usually require a minimum down payment of 20%. Some lenders will go as low as 10%. 

Also, depending on the lender and one’s financial situation, the mortgage rates for jumbo loans may be somewhat higher than those on conventional loans. Note, though, that some lenders can offer rates that are competitive with those of conforming loans. So, it is best to shop around. 

Regarding down payments, in previous years, jumbo loan mortgage lenders frequently required a down payment of 30% of the property’s purchase price. That’s compared to 20% for conventional mortgages. These days, that amount is down to 10-15%.

Types of Jumbo Loans

There are various types of jumbo loans, including fixed- and adjustable-rate mortgages. With the former, the amount that is paid toward the mortgage itself, the amount that comprises principal and interest, will not change.

With adjustable-rate mortgages, one can lock in a low interest rate for the loan’s first 5-7 years, after which the rate is periodically adjusted.

Then there is an interest-only jumbo loan, which permits the borrower to make interest-only payments for the first decade. Subsequently, the loan amortizes into a standard fixed mortgage of 20 to 30 years.

Also, those who are a bit over the conventional loan limit may opt for what is called a combination jumbo loan. Such a loan can permit the borrower to purchase a bigger property without having to meet the tighter jumbo loan requirements.

Is a Jumbo Loan Suitable for You?

A jumbo loan is not for everyone, and just because one can likely qualify for one does not necessarily mean they should take such a loan out. Before going the jumbo loan route, consider:

  1. Eligibility and affordability. It is important to underscore that jumbo loan minimum requirements have, since 2008, become progressively stringent. The borrower will have to have, in addition to a debt-to-income ratio of under 43% and preferably around 36%, a credit score of at least 700. Further, jumbos are most suitable for those who make a minimum of between $250,000 and $500,000 annually, a demographic known as HENRY (high earners, not rich yet). So, one should carefully crunch their numbers.
  2. Consideration of property value and location. One should consider the property’s value and location before committing to taking out a jumbo loan.

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A jumbo loan can truly come in handy if one has a luxury property in mind and needs a higher level of financing than what is conventionally available. However, eligibility requirements for jumbos are more stringent, and there are considerations such as heightened borrowing costs. 

Remember that there are other ways to invest in real estate, while diversifying holdings in the process, that do not involve taking out such a loan.