With the luxury real estate market exploding and high net worth individuals around the world looking to finance the purchase of expensive homes and properties, jumbo loans have been an increasingly popular option for buyers.
However, many prospective buyers are still unclear as to what exactly jumbo loans are, how they differ from conforming loans, and their various advantages and disadvantages.
In order to explain the pros and cons of jumbo loans, we first need to talk about jumbo loans in the context of the home loan market as a whole. Below, we’ll discuss what jumbo loans are and how they relate to other related concepts, such as conforming loans, FHA loans, and secondary mortgage markets to give you a fuller understanding of your options. We hope that with this knowledge, you’ll be in a better position to weigh the pros and cons of jumbo loans and determine if a jumbo loan might be right for you.
Of course, it is good to familiarize yourself with these terms so that you can be a more informed consumer. However, if you would like to learn more, one of our Astar loan officers will be glad to assist you! Reach out to an Astar loan officer today! Email firstname.lastname@example.org or call 888-ASTAR-11 (888-278-2711) to start the loan application process.
What Are Jumbo Loans and How Do They Differ from Conforming Loans?
The best way to understand what jumbo loans are is to understand what they are not. A jumbo loan is a loan that exceeds the loan value of a conventional conforming loan. The Federal Housing Finance Agency set parameters for defining conforming loans. One of the parameters for a loan to be considered conforming is that it is below the conforming home limit in the region that it is offered.
Conforming loan limits can change every year and vary depending on the state and country of the property. The baseline or minimum conforming loan limit, which applies to a majority of states in the US, is $548,250. That means that loans that exceed that amount are considered nonconforming in most counties in the US.
The conforming loan limit is higher for particularly expensive regions in the US. These regions include certain counties in California, Hawaii, Alaska, and New York. You’ll have to look up the conforming loan limit in your area to determine whether a conforming loan will be sufficient to buy your desired property, or if you’ll need to apply for a jumbo loan.
Jumbo loans are loans that exceed the conforming loan limit. So, why would a buyer want to qualify for a conforming loan? Well, the reason is that conforming loans offer a number of benefits that nonconforming loans don’t.
First of all, conforming loans typically have lower interest rates than non-conforming loans which can represent huge savings for homebuyers over time. Of course, the interest rate of each loan will be individually calculated based on the borrower’s credit history, debt-to-income ratio, and loan application. However, in general, lenders are willing to offer lower interest rates for conforming loans even for borrowers that have less convincing applications than their jumbo loan-borrowing counterparts.
Why Conforming Loans Offer Lower Interest Rates
Many borrowers aren’t aware of why conforming loans offer lower interest rates. One of the main reasons is that conforming loans can be bundled and securitized into financial products that can then be sold to inventors in what is known as the secondary mortgage market.
The secondary mortgage market was created in 1968 through the creation of two semi-governmental entities commonly called Fannie Mae and Freddie Mac. Fannie and Freddie were created to lower interest rates for homebuyers by buying up mortgages, packaging them with other mortgages, and then selling them to investors and brokers on Wall Street as securities. This allows investors to profit from the interest paid on the loan and distributes the risk of the mortgage to lenders, which is why it lowers interest rates for borrowers.
The Pros of Jumbo Loans
The primary advantage of jumbo loans is that they allow borrowers to receive home loans that exceed the maximum conforming loan limit in their area. In this way, jumbo gives big-ticket borrowers more working capital to finance the purchase of expensive properties.
If borrowers are planning to rent out the property they buy or use it for business purposes, a jumbo loan might give that borrower the ability to buy a property that could have been difficult for them to finance on their own. In this sense, a jumbo loan might open up business opportunities that would otherwise be inaccessible.
Given the lucrative opportunities in the luxury rental market, many investors use jumbo loans to buy luxury properties and rent them out to tenants. This is especially true since jumbo loans are not subject to the same government regulations as conventional loans.
The Cons of Jumbo Loans
Jumbo loans do come with a substantial set of downsides when compared to conforming loans. As discussed, interest rates on jumbo loans are generally substantially higher than conforming loans, since they can not be sold on the secondary real estate market. But, the disadvantages of jumbo loans don’t stop there.
Jumbo loans also include larger interest rates. In general, lenders often bump up interest rates by one to two percentage points or more for jumbo loans.
Higher down payments are also typical of jumbo loans. It’s not uncommon to request down payments as high as 20% of the loan amount or more for jumbo loans to offset the increased risk taken on by lenders.
Lenders of jumbo loans also typically have more stringent credit restrictions for borrowers. They also take a closer look at borrowers’ cash flow. Lenders require more favorable debt-to-income ratios for jumbo loans, with debt-to-income ratios larger than 36% rarely being accepted.
Additional appraisals are also often required for jumbo loans to give lenders an extra layer of certainty as to the market value of the property. Lenders also look to see what sorts of other assets borrowers have available and how liquid those assets are to know if they could be leveraged or liquidated to pay back a jumbo loan. Finally, jumbo loans also typically require higher closing fees, representing another expense for borrowers.
In conclusion, it’s easy to see the many benefits offered by conforming loans including lower interest rates, smaller down payments, fewer credit and cashflow requirements, and smaller closing fees. However, for borrowers with great credit scores that are buying properties that exceed conforming loan limits, a jumbo loan is absolutely the right option. Jumbo loans offer the benefit of larger value loans that they can use to purchase exclusive, expensive properties for business or personal use.