When you buy a home, you’ll need financing. You may need a jumbo loan if you need to borrow more than the current conforming limit. Before borrowing a jumbo loan, you should understand its requirements and limitations to ensure it’s right.
What are Jumbo Loans?
A jumbo loan is a loan that exceeds the current conventional loan limits. For example, in 2022, the conventional loan limit is $647,200; in 2023, it increases to $726,200. Jumbo loans are also often called non-conforming loans because they exceed the conforming loan limits.
Because jumbo loans are riskier, lenders often have stricter underwriting requirements to reduce the risk of default. However, they may also have higher rates or costs to compensate for the risk.
How Does a Jumbo Loan Work?
Jumbo loans aren’t backed by government agencies, such as the FHA or Fannie Mae. This means the lender is 100% at risk if a borrower defaults.
However, it also means lenders can create their own guidelines and offer loans that government agencies might not allow. For example, they can set their own self-employment requirements guidelines or accept alternative income documentation. But they may also require larger down payments or better credit scores than other loan programs require. Check the best apps for validate your credit score
How to Qualify for a Jumbo Loan
Qualifying for a jumbo loan may look different than qualifying for a conventional loan or government-backed option.
Each lender has different requirements, but here’s what to expect. You may be eligible for a jumbo loan if you can meet most of these requirements.
Down Payment
Most lenders require a 20% – 30% down payment versus a 3.5% – 5% loan FHA and conventional loans require.
The down payment reduces the lender’s risk because you have ‘skin in the game.’ You’re more likely to make your payments if you have a large amount of your money invested in the home. If you default, lenders have a better chance of getting most of their money back because you only borrow 70% – 80% of the property’s value rather than 95 – 97.5%.
Credit Scores
Like down payments, each lender has different requirements, but on average, expect lenders to look for credit scores of 700 or higher.
Your credit score tells lenders how financially responsible you are, and if you have a low credit score, it can be a high risk for them. You may be able to get a jumbo loan with a lower credit score, but you must have compensating factors, such as a large down payment.
Debt-to-Income Ratio
Lenders also closely evaluate your debt-to-income ratio, which measures how much money you owe versus how much you earn.
The higher your DTI, the riskier you are to a lender. When you have a low debt ratio, it shows lenders that you have enough free capital to afford your mortgage. Aim for a debt-to-income ratio of 43% or less for the best chances of approval.
Cash Reserves
Unlike conventional and government-backed loans, you’ll likely need cash reserves to ensure you can afford the loan. Most lenders require six to twelve months of mortgage payments. So, for example, if your mortgage payment is $2,000, they’d require you to have $12,00 to $24,000 in a liquid account, such as a savings account.
Who Should Borrow a Jumbo Loan?
If you’re buying a home in a high-cost area or can afford a higher mortgage payment, you may borrow a jumbo loan. Many people with capital but don’t want to tie it up in their homes borrow jumbo loans but have the reserves on hand should they need them. This allows you to keep your assets liquid and buy your dream home.
Jumbo Loan Benefits – What are They?
If you need a jumbo loan, there are several advantages to them, including:
- You can borrow higher loan amounts without a limit as long as you can prove you can afford it
- You may have more options for different loan programs
- You can buy more expensive homes without having a lot of capital
Jumbo Loans vs. Conforming Loans
The largest difference between jumbo and conforming loans is the loan amount. Conforming loans have a limit, and jumbo loans don’t.
Other differences include:
- Jumbo loans may have more options for loan programs
- Borrowers often pay higher interest rates on jumbo loans
- Jumbo loans require higher down payments and better credit scores
- You may need to prove you have reserves to get approved for a jumbo loan
- Jumbo loans have higher interest rates and fees
Jumbo Loan Considerations
Before applying for a jumbo loan, consider these factors. They shouldn’t deter you from applying for a jumbo loan but should help you understand the difference between conventional loans and what you should expect.
You Must Have a Consistent Income
Jumbo loans are riskier for lenders, so you must prove you have consistent income. Usually, they want borrowers at the same job for at least two years or with a solid income history in that time that didn’t fluctuate.
You’ll Pay Higher Interest Rates and Closing Costs
Jumbo loans have a higher risk, which usually means paying higher interest rates and closing costs. This varies by lender but is something to consider when applying for a jumbo loan.
Jumbo Loans may be Manually Underwritten
Lenders often manually underwrite jumbo loans, which can work in your favor. However, if you have unique circumstances, you might still get approved because it’s a person, not a computer, underwriting your loan.
Bottom Line
Jumbo loans are a great way to buy your dream home with financing. They have strict underwriting requirements, including a large down payment, high credit scores, and low debt-to-income ratios. Understanding how they work and how to get the best rates and terms is the key to affording your dream home.
