As the homebuying season kicks off in earnest in the spring, buyers may find that the lack of inventory = higher prices. If your dream home comes with a steep price tag, you may need to apply for a jumbo mortgage to finance it, instead of a “conventional” mortgage.
What’s the difference? In short, conventional mortgages are backed by Fannie Mae & Freddie Mac, whereas Jumbo loans are not. These jumbo loans are sizes of $500,000 or more that an individual or couple are borrowing to finance a luxury property, or homes in a highly competitive local real estate market.
Unfortunately these days, many of the top 25 cities in the US have become highly competitive markets. Jumbo loans can be especially difficult for first-time homebuyers to obtain, as lenders often require a higher down payment %, additional cash reserves in your bank account, and unique underwriting requirements. STEM Lending‘s expert mortgage consultants can help walk you through the details to see which loan–conventional or jumbo–makes sense for you.
Ok, but apart from being large, what exactly are jumbo mortgage loans, and how do I know if it’s the right loan option for me, instead of a smaller conventional mortgage loan?
Fannie Mae, Freddie Mac, and Loan Limits
Roughly 90% of all mortgages written in the U.S. are backed by two quasi-public government sponsored enterprises (GSEs), Fannie Mae and Freddie Mac. These two agencies “securitize” these loans by purchasing loans in bulk, packaging them up and reselling them in bond form. Fannie or Freddie will do this for almost any mortgage that conform to their underwriting guidelines, which factor in a borrower’s credit score and history, debt-to-income (DTI) ratio, the mortgage’s LTV (loan-to-value) ratio, and the size of the loan.
Late last year, the Federal Housing Finance Agency (FHFA) announced the maximum conforming loan limits for mortgages to be acquired by Fannie Mae and Freddie Mac in 2018. In most of the U.S., the 2018 maximum conforming loan limit for one-unit properties will be $453,100, an increase from $424,100 in 2017.
Loan limits are based on median home prices in the county or MSA (metropolitan statistical area) in which the property is located. For 2018, all but 71 counties or MSAs will get an increase. The new limits are effective for loans closed on or after January 1, 2018. If you’re curious to see if your local area was affected, you can find out by checking Fannie Mae’s Loan Limit Look-Up Table.
When mortgage loans from a potential lender are above the $453,100 threshold, that’s when the loan becomes a “jumbo.”
When it comes to jumbo loan standards, please be aware that even if the mortgage loan is not a conventional, most lenders will still have strict underwriting guidelines to qualify a borrower, especially first-time homebuyers.
Qualifying: Conventional vs. Jumbo Mortgages
Because jumbo loans aren’t backed by any of the GSEs (Fannie, Freddie, or GNMA), lenders are exposed to more risk from the borrower, as the lender can’t readily sell the loan onward to Fannie Mae or Freddie Mac; they may have to keep it on their own balance sheet. As a result, most lenders will require proof or documentation for the following items:
- Two years of income: Have the last two years’ worth of your W-2 or tax documents proving you have a reliable, consistent source of income. Nowadays, many lenders allow you to docu-sign or E-sign to authorize them to pull their tax transcripts. Lenders will also want to see you have enough “cash reserves” in your bank account to cover anywhere from 3-6 months of mortgage payments. Why? Again, the lender needs to ensure that you can cover the mortgage without any late payments in at least the first 12-13 months of your mortgage. They will perform underwriting with the question of “does this individual have the ability-to-repay this mortgage?”
- Sterling credit score and history: Generally you need a credit score of at least 640 (considered “fair”) before a lender will approve you for a conventional mortgage. However, it is highly unlikely lenders will approve you for a jumbo mortgage if your credit score falls below the 700-720 range. However, there are some non-bank lenders and smaller banks who may have created specific high-balance mortgage loans specifically for borrowers whose free cash-flow, income & assets support the mortgage, even if they have <700 FICO scores, so there is some evidence this is beginning to change.
- Debt-to-Income ratio (DTI): Conventional mortgages are almost always qualified mortgages (“QM”), which means that your debt-to-income ratio (your monthly debt obligations compared to your monthly income) needs to be 43% or less. This same rule would apply for jumbo mortgages that are also qualified mortgages, but often lenders will want you to have a lower DTI since the loan is so large. However, the age-old 43% DTI rule of thumb is also starting to change, as Fannie Mae announced July 29, 2017 that they would be raising the DTI ceiling to 50% in an effort to give potential homebuyers more options than just an FHA loan. Borrowers will still have to be vetted by Fannie Mae’s automated underwriting system called Desktop Underwriter (DU), but this is a very big change, especially in an era where the federal standard DTI is still 43%.
- Down payments: A couple of years ago, jumbo mortgage lenders would have required higher down payments – around 30% or more – compared to conventional mortgages, which are typically 20%. However, the ratio of down payments to mortgage value has relaxed for both categories, with major lenders such as Quicken, SoFi, PNC Financial Services Group and Wells Fargo recently offering jumbo mortgages for as little as 10% down. As a caveat though, in some of the nation’s most competitive local markets like San Francisco, Seattle, Denver, and New York, the individuals buying those homes are still putting down an average of 30%. Sometimes what the lender allows regarding down payments (10%) may actually make your bid less competitive for a seller who’s deciding between 5-6 different offers.
STEM Lending makes it easy to compare dozens of mortgage rates, all in one place, with 1 application. In recent months, the average annual percentage rate (APR) % for a jumbo mortgage actually be in-line to or below with mortgage interest rates for conventional mortgages. In fact, it’s not uncommon to see a lower APR for a jumbo mortgage. This is because, as we talked about earlier, the bank is likely going to have to balance sheet your mortgage loan (i.e. hold it on their own balance sheet, using their own capital). As a result, many banks price jumbo mortgage loans below or in-line with conventional mortgage loans as an incentive for prospective borrowers who might be good private wealth clients.
The Tax Bill
If you’ve ever purchased a home, you probably already know that you can deduct the interest you paid on your mortgage for any given year, from your taxes. But you may not know that there are limits to how much of a deduction you can take.
By law, you can deduct mortgage interest, as long as the mortgage itself is at or less than $1 million. If your mortgage is larger than $1 million, you won’t get the full deduction. For example, if you took out a $2 million jumbo mortgage that accrues $60,000 in interest a year, you can only deduct $30,000 – the interest on the first $1 million of your mortgage.
The Bottom Line
Getting a mortgage these days is unnecessarily stressful, and filled with potential obstacles. Jumbo mortgages are much more valuable to a bank looking for clients who they can potentially cross-sell other financial products, like private wealth services. Jumbo mortgage loans are also not backed by the government, or government sponsored enterprises like Fannie Mae or Freddie Mac. Borrowers looking to qualify for a jumbo loan must have considerable assets and a strong credit history. Still, there are signs that jumbos are becoming easier to obtain, especially as non-banks continue to grab market-share from the large money-center retail banks.
Is the conventional mortgage or jumbo mortgage loan the right option for you? Give us a call at 646-798-1800, or email us at email@example.com, and we’ll help you find the best mortgage for you, regardless of lender.