What Is a Jumbo Loan and When do I Need One?

Key takeaways

• The FHFA guarantees all home mortgages under a certain dollar amount. These “conforming” home loans are eligible for purchase, guarantee and securitization by Fannie Mae or Freddie Mac. A jumbo loan is one type of “nonconforming” home loan.

• Although jumbo loans used to incur significantly higher interest rates than conforming mortgages, it’s possible today to get a jumbo loan at a rate competitive with, or even lower than, traditional mortgages.

• Understand that the qualifications for a jumbo loan are similar to those of a confirming home loan, but stricter.

What is a jumbo loan?

The FHFA sets a maximum loan guarantee adjusted annually for inflation. Loans that fall below this limit are “conforming” loans.

These conforming loans do meet Fannie Mae and Freddie Mac’s underwriting guidelines, allowing the mortgages to participate in the secondary market. For 2022, the maximum limit for a conforming loan is $647,200 for most locales. If you live in an area with higher home values, the limit extends to $970,800.

This means a “jumbo” loan is any home mortgage over those conforming loan maximums.

What makes these loans different?

Lenders consider jumbo loans riskier than regular mortgages.

Without the guarantee from the federal government, the lender isn’t as protected if the borrower defaults. The sheer value of the loan also creates greater risk. If the borrower defaults, the bank could lose much more money than on a conventional home loan.

The general qualifications are similar, though stricter. For example:

• Credit score: You need a great score, not just a decent one. Lenders are looking for at least a 700, sometimes even a 720 minimum.

• Debt-to-income (DTI) ratio: Lenders look for borrowers with a DTI ratio of 36% to 43%. This shows banks your ability to pay your debts.

• Qualified mortgage: A qualified mortgage is a mortgage meeting certain characteristics the Consumer Financial Protection Bureau determines as less risky.

• Cash on hand: You must prove to the bank that you can meet your mortgage payments. While the required income and cash reserves will depend on your particular loan amount, most lenders will require 30 days of pay stubs and tax forms from the last two years. Requirements are more stringent if you’re self-employed (e.g., you may need to have enough cash to cover six months of payments).

• Other requirements: Lenders require documentation of all other loans, and proof of ownership for certain assets.

• Down payment: Lenders of jumbo loans historically required borrowers to put down at least 30% of the purchase price. However, more lenders now accept as little as 10% to 15%. Putting more down will reduce your monthly payments.

Finally, jumbo loans have typically had higher interest rates to reflect the increased level of risk. But like with down payments, lenders today offer an APR comparable to traditional mortgages or even lower in some cases.

When should I get a jumbo home loan?

Homebuyers seeking a luxury home or property frequently need a jumbo loan.

Lenders often consider these loans appropriate for individuals earning between $250,000 and $500,000 per year. These HENRYs (high earners, not rich yet) are well on their way to building millions in assets but haven’t quite gotten there yet.

This class of earners usually doesn’t have the cash to buy an expensive property outright. Banks and other lenders offer jumbo loans regardless because HENRYs usually have a longer credit history, higher credit score and significant retirement savings.

Is a jumbo loan right for you?

Owning a home provides certain tax benefits. One of the most common is the mortgage interest deduction.

After the 2017 Tax Cuts and Jobs Act (TCJA), homeowners who took out a mortgage after Dec. 15, 2017, may only deduct the interest paid on up to $750,000 of their mortgage debt. Interest paid in excess of that maximum is non-deductible.

For example, say you have a mortgage totaling $3 million at 5% APR. If that loan accrues a total of $150,000 in interest for the first year, you can only deduct $37,500 of the interest, which is the amount attributable to $750,000 of the loan.

You might consider taking the time to crunch the numbers. It’s possible that taking out more than one smaller, conforming mortgage could save you in interest payments.

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