Jumbo Loans: The Big Myth

Jumbo loans earned that moniker because the loan amounts are greater than what Fannie and Freddie currently allow. Each year Fannie Mae reviews the current housing market and prevailing median property values. If the property values are higher year-over-year, the conforming limit is adjusted upward accordingly. This analysis takes place each fall so if home values nationwide are up by 10 percent from the previous year, the conforming loan limit is also increased by 10 percent for the following year. In the rare occurrence when home values actually fall from one year to the next, there is no adjustment for the coming year and the conforming loan limits actually stay the same. The conforming loan limit for 2018 is $453,100. Anything above that amount is considered jumbo. Even if the loan were $453,150, it’s still a jumbo. That however really never happens because borrowers would go ahead and make the extra $50 dollar down payment to stay in the conforming range. Why would this happen?

How it Works

Jumbo loan programs carry higher rates compared to conforming ones. But many consumers think that interest rates are much higher than a conforming one. “Higher” however is a relative term. It used to be that jumbo rates were considerably higher than conforming ones and home buyers would do whatever they could to try and stay below the jumbo floor. Yet today the spread between a jumbo and a conforming loan is really rather small, say around one-half of one percent higher.

There is another category of loan types that fall in between a conforming and jumbo that lenders refer to as “high balance conforming” or simply high balance. In certain parts of the country where the overall median property values are much higher compared to most other places, Fannie and Freddie both make allowances for such areas and offer a high balance conforming loan. For instance, Fairfax, Virginia is considered to be a high cost area and the conforming limit there is higher than $453,100 at $625,000. In our market area, the high balance conventional loan limit is $679,650. There is a slight adjustment to the rate for a high balance loan but will still be a bit lower than prevailing jumbo rates.

Guidelines for Jumbo Loans

Jumbo loans are approved in pretty much the same manner as conforming loans. However, the guidelines for jumbos are a bit more stringent, although not by a lot. Jumbo loan programs can require higher credit scores for instance. For instance, a minimum credit score for many jumbo loans is closer to 700 while the minimum credit score for most conforming loans is around 620.

Jumbo loans are not restricted by property type. As long as the property being purchased is for a residential one, a jumbo loan can be used. For instance, not only can a jumbo be used to finance a single-family home but also a duplex. And, if the buyer occupies one of the units and rents out the other side, it is still considered an owner-occupied property even though there is rental income being received. In addition, a three or four-unit property is eligible for jumbo financing. When a property is considered owner-occupied, it receives slightly better rates than a second home or investment property. Which by the way can also be financed with a jumbo loan.

The Down Payment Myth

But perhaps the biggest jumbo loan myth is how much of a down payment is required. It used to be that jumbo loan programs across the board required a down payment of 30 or even 40 percent or more. Because of this, it’s still thought that jumbo loans require a large down payment. But that’s not the case. A jumbo loan can be structured with a down payment of as little as 5 percent and still have competitive monthly payments. What does need to happen when properly structured is the jumbo loan amount must be at or below 80 percent of the sales price of the home. Just like conforming loans, when the loan amount is more than 80 percent of the value, private mortgage insurance will be required. However, a private mortgage insurance policy for a loan amount of say $800,000 isn’t available. Private mortgage insurance policies apply to conforming loans. Still, a 20 percent or more down payment is not a requirement for a jumbo loan. Instead, borrowers can take out two loans, a first and a second. And that’s the myth-buster and lenders refer to the structure as an 80-10-10 or an 80-15-5. The 80 represents the first mortgage, the first 10 indicates the second and the final 10 or 5 is how much of a down payment is needed.

Let’s look at a home with a sales price of $600,000. With a 20 percent down payment, the loan amount is $480,000 which is relatively close to the conforming limit and the lower rates that go along with it. With an 80-10-10, the first mortgage would be right at the conforming limit of $453,100 and the second of $60,000. The down payment is also $60,000. When using a first and a second for a jumbo, the down payment will be more than just 10 percent. It will be the difference between the 80 percent level and the conforming limit. The buyers need to pay down the mortgage to meet this amount.

Otherwise, the buyers would need to come to the settlement table with $146,900, the difference between $600,000 and $453,100. The rates for the second mortgage will be a bit higher compared to the first lien but not by much and still lower than what a single jumbo loan would have.

Again in our market, we’re in a high balance area. The high balance loan limit is $679,650. Let’s say a home is priced at $900,000. A 20 percent down payment is $180,000. But if we make the first loan at the high balance limit of $679,650 and make a 5.0% down payment, the difference is $175,350 which is the second mortgage. The down payment is then $45,000, not $180,000.

Final Takeaway

It can get a bit confusing sometimes when going through a bunch of numbers but after speaking with Shawn to see if this is a good alternative for you, you’ll be provided with various arrangements that clearly spell out what your monthly payments and loan amounts will be. Whether you’re saving up for a higher-priced home or you do have cash readily available for a down payment and closing costs but would rather not cash in an account, there are options that can get you into that home now that allow you to keep more of your own money and finance your purchase with competitive rates.