Jumbo Loan: Explained

Jumbo loans are true to their name – Big Loans. In the mortgage world, the term “jumbo” refers to a loan class that is underwritten to conventional or similar standards but for amounts larger than what is considered typical.

Conventional Loan Basics

To understand what makes a Jumbo loan different, it helps to learn the basics of the conventional loan product. A conventional loan is a mortgage offered by a private lender and is usually underwritten to the standards set forth by one of the government-sponsored enterprises (GSE’s). An example of a GSE is The Federal Home Loan Mortgage Corporation, also known as Freddie Mac. When a loan is underwritten in accordance with conventional guidelines, the related GSE will purchase said loan when it enters the secondary market. In other words, the GSE guarantees they will purchase the debt from a private lender if the lender (such as Ruoff Home Mortgage) adheres to conforming conventional guidelines. This is different from loans being insured by a true government institution, such as the Federal Housing Administration (FHA).

Basic conventional guidelines stipulate, among other things, a maximum loan amount based on average property values for a geographic region. Jumbo loans exceed this maximum loan amount and therefore do not conform to conventional underwriting guidelines. Jumbo loans may be offered via private lending or more exotic loan programs. In addition to the amount being financed, jumbos also require higher credit scores and a bigger down payment. Underwriting requirements are more stringent for a jumbo because the primary mortgage lender must either find a financial partner other than a GSE to purchase the debt or take on the risk of holding the loan-in house.

Conforming Loan Amounts

At the time of this publication, the maximum conventional loan amount limit, also known as the “conforming” loan amount, was around $500,000 for most areas within the United States. Alaska, Hawaii, Guam, and the U.S. Virgin Islands have higher conforming loan amounts commensurate with average property values in those areas. If a borrower needs to finance more than the conforming loan amount, then they could try to demonstrate that the subject property is in a high-cost area. If high-cost guidelines cannot be met, the borrower might be a candidate for a jumbo loan.

Application Process

The application process for a jumbo begins just like a conventional mortgage would. The buyer contacts a loan officer and fills out a standard application form. The loan officer can then help the buyer determine whether a jumbo product is the right fit for his or her needs. Since the bank will be loaning a sizable amount and may even be holding the loan in-house, the lender’s risk exposure is high. It is therefore reasonable that underwriting guidelines will be more stringent than they might be for a conventional or FHA product. Borrowers should be prepared to present adequate documentation of income, assets, and good credit. The down payment requirement will also be higher, probably twenty percent or higher. Interest rates are also priced higher for jumbo loans.

Why Would Anyone Want a Jumbo Loan?

First and foremost, because they want a big house. Jumbo loans do mean more debt exposure and therefore more risk to a buyer, but under the right circumstances bigger loans can benefit homeowners. In a market where home values are rising, buyers are more likely to take on the risk of a higher-priced home in exchange for the anticipated appreciation. A second benefit is that some borrowers, regardless of their cash reserves, may want to retain control over their existing capital. This way they keep funds free for other investments. In a low-rate environment, jumbo loans provide borrowers with sizable spending power. Finally, appreciation in some areas, especially large, densely populated cities, has overrun the maximum loan amounts offered via conventional programs. Jumbo loans provide an option to borrowers in these metropolitan areas where conforming guidelines have not yet caught up with rising home values.