What is a jumbo mortgage? Jumbo Home Mortgage Loans Explained Plain English.

What is a jumbo mortgage?

If you’re in the market for a high-priced, luxury home, you will likely have to obtain a jumbo mortgage to finance the purchase.

Jumbo mortgages are loans that exceed the mortgage limit for conforming loans. A conforming loan is one that meets the purchasing guidelines of Fannie Mae and Freddie Mac. These two government entities will often buy conforming mortgages from lenders so that financial institutions have more cash on hand to fund more mortgages.

To conform to Fannie Mae and Freddie Mac guidelines, mortgages have to meet their guidelines for the downpayment, the borrower’s credit score and post-closing reserves. In addition, a conforming loan cannot exceed a certain amount borrowed.

In most areas of the country, the limit is $417,000 for a conforming mortgage. Several markets have higher conforming limits because of the high cost of real estate, including Hawaii, New York City, San Francisco and Los Angeles. Conforming loan limits in some of these areas may be as high as $625,000.

There are also higher limits for the number of units within a property. For example, a conforming loan for a four-unit property in most of the country can be as high as $800,000.

Higher risk for jumbo loans
Loans greater than the conforming limits are usually called jumbo mortgages or non-conforming mortgages. Since these mortgages cannot be sold to Fannie Mae or Freddie Mac, they add a higher level of risk to lenders, who either have to keep them on their books or sell them to outside investors.

Jumbo loans also carry more risk because luxury homes are typically more difficult to sell, and they are prone to more valuation shifts than moderately priced houses. Because of this, lenders will often obtain two separate appraisals before signing off on a jumbo loan.

Historically, because of the extra risk, there were more stringent loan requirements for jumbo loans. Borrowers typically needed higher credit scores to obtain a jumbo mortgage than they would with a standard loan. Also, homeowners also needed to have money in reserve post-closing, often enough to make a year’s worth of mortgage payments. And since mortgage insurance is typically not available on jumbo mortgages, borrowers have historically almost always needed to pay 20 percent down.

Jumbo loan borrowers have also historically paid a slightly higher interest rate than those available on standard mortgages.

Recent relaxation of jumbo loan requirements
Jumbo loans were even harder to obtain immediately following the 2008 housing crisis, as fewer investors wanted to buy mortgages on the secondary market. That has recently changed, and so have the requirements to obtain a jumbo loan.

Rates for these mortgages have reached historic lows in recent years, and the interest on loans up to $1 million can often by tax deductible. Borrowers can now often get financing for as little as 10 percent down for loan amounts of $1 million. What’s more, many jumbo mortgage lenders may allow second mortgages for a combined loan-to-value ratio of up to 90 percent.

Those in the market for a jumbo loan can choose between a conventional fixed rate mortgage or adjustable rate mortgages. One popular option is a 5/5 ARM in which the interest rate is fixed for the first five years and adjusts ever five years after that.

Many lenders have relaxed the minimum credit scores they require for jumbo mortgages. Plus, if you can put at least 20 percent down, lenders will often allow a higher debt-to-income ratio.

Some large banks also offer a re-amortization feature on loans they keep instead of selling. This allows borrowers who pay extra on their mortgage to decrease their payment by having it recalculated. This can occur if the homeowner uses a bonus or other large source of funds to make a substantial extra payment.