Okay, the main difference between a conforming home loan and a jumbo loan is simply the loan amount. Conforming loans are labeled conforming because they conform to guidelines set by Fannie Mae or Freddie Mac. For most parts of the country the maximum loan amount to still be considered a conforming loan is $484,350. Anything above that is a jumbo loan. But there are also some important differences between the two categories.
Private Mortgage Insurance (PMI)
One difference involves the private mortgage insurance industry, or PMI. Years ago, banks would require a much larger down payment than they do today. If a loan went into default, the bank was on the hook for the entire amount. To offset this risk, banks would ask for a down payment of 30 or 40 percent or even more. This obviously kept many on the rent rolls and out of home ownership. But in the late 1950s an insurance company came up with an idea that would insure the difference between the buyer’s down payment and 80 percent of the sales price. Any conforming loan above 80 percent would require PMI. Today for example, a conforming loan can be as high as 95 percent of the sales price and in some instances 97 percent.
Yet there is no PMI for jumbo loans. This caps the loan amount at 80 percent of the sales price. On a $700,000 purchase price with 20 percent down, the loan amount would be $560,000, or a jumbo loan. If someone wanted to pay the loan down to $484,350 to get a slightly lower conforming rate, they certainly have that option.
Approval Guidelines for Jumbo Loan
Approval guidelines for a jumbo loan are generally a bit more stringent. Not by a whole lot but a more difficult in general. This also affects minimum credit score differences between conforming and jumbo loans. For most conforming loan programs the minimum credit score can range from 600 to 620. For a jumbo loan, the minimum credit score can be somewhere closer to 700 to 740.
Debt ratios, expressed as a percentage of gross monthly income can be as high as 50 for a conforming loan. This means if someone makes $6,000 per month, monthly debt, including principal and interest, taxes, insurance, or PITI, along with other installment and revolving debt could be no higher than 50 percent of $6,000, or $3,000. Jumbo guidelines like to see debt ratios closer to 43.
Cash reserves are generally more restrictive with jumbo loans. Cash reserves in the mortgage industry counts how many months of mortgage payments are left in the bank after all bills are paid each month. Expressed as the number of months required, a conforming loan might want to see three months’ worth of house payments in the bank. If the total mortgage payment is $3,000 and the cash reserve requirement is three months, there needs to be $9,000 in available funds after the loan has closed. Jumbo loans on the other hand can require anywhere from six to twelve months of reserves left in the bank after the buyers have made their down payment and paid for associated closing costs.
Also note that different lenders can add additional qualifying guidelines, referred to as “overlays.” This means one jumbo lender might want to see a 720 minimum credit score while another would prefer 740. As long as the lender applies the additional guidelines equally for all loan applicants, the lender has the prerogative to do so.