What Are Jumbo Loans?
As a borrower prepares to buy a home, he or she needs to decide how expensive a home, and hence, how large a mortgage, the borrower can afford.
If a borrower wants a home whose mortgage is $417,000 or above, then a non-conforming or "jumbo" loan may suit their needs. The article below should help a potential borrower to understand the advantages and disadvantages of a jumbo loan.
A borrower choosing the jumbo loan or 'non-conforming' loan may finance a more expensive house whose mortgage balance and interest rate are likely to be higher than the balance and interest rate are with a more conventional conforming loan.
As the borrower prepares to purchase a new home, one of the questions they may consider is, "how much house do I want?" Put another way, they need to figure out how much expensive a home, and hence how large a mortgage, they want and can afford.
If the buyer wants a more expensive home, with a mortgage of $359,560 or above, then they need a non-conforming or "jumbo" loan.
If the borrower is comfortable with a loan whose balance and interest rate are likely be higher than is the case with a conforming loan, than a jumbo may be a better choice.
This article focuses on jumbo loans, and enables a borrower to decide if a jumbo loan meets their financial needs and goals, by answering the following questions about it:
- What is it?
- How does it work?
- What are the pros and cons?
What is It?
In the conventional mortgage market, loans are classified as either "conforming" or "non-conforming". Two quasi-government agencies, Fannie Mae and Freddie Mac, are responsible for the guidelines that determine this classification.
Fannie Mae and Freddie Mac are stockholder-owned corporations created by Congress. These two companies underpin the mortgage industry by buying conforming loans from mortgage lenders, packaging the mortgages into securities and selling the securities to investors. This way, they ensure a steady stream of affordable funding for home loans. Therefore, Fannie Mae and Freddie Mac ensure the availability of mortgage credit for borrowers who need it.
The guidelines they establish that determine if a loan is "conforming" or not include:
- Maximum loan amount
- Minimum borrower credit scores needed to qualify for mortgages
- Minimum borrower income needed to qualify for mortgages
- Down payment requirements
- Location and type of suitable properties
A "jumbo" loan is so-called if it exceeds the maximum loan amount that Fannie Mae and Freddie Mac allow for conforming loans. (Currently that limit for a single-family home is $359,650.)
Quite simply, if the borrower wants a large, expensive home, they need a jumbo loan.
Jumbo loans are bought and sold on a much smaller scale, compared to conforming loans. The interest rate on a jumbo is usually higher than with a conforming loan. Additionally, not all lenders handle jumbo loans, so if the borrower needs one, they may need to do additional legwork to find a lender who offers this loan option.
How does it work?
As noted above, jumbo loans differ from conforming loans in that they exceed the maximum loan amount established by Fannie Mae and Freddie Mac.
Fannie Mae and Freddie Mac adjust these maximum amounts each year, based on the results of a survey that the Federal Housing Finance Board (FHFB) conducts. The FHFB polls US lenders monthly to determine the average value of single family homes bought with conforming mortgages. Based on that average value, Fannie Mae and Freddie Mac adjust the maximum loan amounts for single-family homes and other property types.
The following table illustrates the maximum loan amounts these two agencies have established for the year 2005, as compared to 2004 and 2003, for different types of properties.
2006 Conforming Loan Limits
Number of
UnitsMaximum original
principal balanceAlaska, Guam, Hawaii,
and U.S. Virgin Islands only1 $417,000 $625,500 2 $533,850 $800,775 3 $645,300 $967,950 4 $801,950 $1,202,925
It should be noted here that the maximum loan amount is higher in Alaska, Hawaii, Guam and the Virgin Islands. Additionally, properties with five or more units are considered commercial and are handled under different rules than residential properties.
The loan limit trend is an upward one. These higher limits ensure that more borrowers can qualify for conforming loans instead of jumbos, and save on interest costs as a result.
As noted above, jumbo loan interest rates are higher than those of conforming loans (ranging from 0.11-0.70 basis points higher). Additionally, because jumbo loans are not financed by Fannie Mae and Freddie Mac, but instead by private-label securities, jumbos lack the interest rate standardization that Fannie Mae and Freddie Mac provide for conforming loans. There is a great deal more regional variability in jumbo interest rates than is the case with conforming rates.
It should be noted, however, that jumbos do not significantly differ from conforming loans in terms of type. A jumbo loan can be a fixed-rate, adjustable-rate (ARM) or hybrid. The jumbo version of these loan types will have a higher balance and a higher interest rate.
If a borrower is comfortable with carrying a higher loan balance and a higher interest rate than is the case with a conforming loan, then a jumbo may be an appropriate choice. If buying "more house" is part of the overall financial and life goal, then a jumbo can provide the borrower with more flexibility.
The pros and cons
A jumbo loan is a good choice if a mortgage is above the maximum loan limit mandated by Fannie Mae and Freddie Mac. As with any other mortgage option, it has advantages and disadvantages.
| Pros | Cons |
|---|---|
| Enables a borrower to afford “more house” | Higher loan balance |
| Higher interest rates | |
| More regional interest-rate variability than is the case with conforming loans | |
| Not all lenders offer jumbos |
Higher interest rates
More regional interest-rate variability than is the case with conforming loans
