Jumbo loans, which are larger than conforming loan limits set by Fannie Mae and Freddie Mac, can be an attractive way to finance the purchase of a large or luxury home. However, they tend to be more costly than other types of mortgages and present lenders with greater risks as there are no government or mortgage-backed securities backing them. As a result, lenders have stricter lending criteria for jumbo loans than for conventional conforming loans.
Jumbo borrowers have more credit scoring and down payment options than their conventional homebuying counterparts, but it’s still essential that you can afford the monthly payments on a jumbo loan before applying. You may need to provide cash reserves in case of emergency.
Credit Score: To qualify for a jumbo loan, lenders typically require that borrowers have a high credit score – usually above 660. Individuals with lower scores will need to work on improving their credit and saving up for an down payment; both of which can take time.
Debt-to-income ratio: Lenders prefer lower debt-to-income ratios for jumbo loans. This is because a larger mortgage amount typically means larger monthly payments, placing additional strain on your finances. On average, lenders prefer DTI levels around 36% for these borrowers.
Down Payment: Lenders may require a down payment of up to 10% on jumbo loans for single-unit homes, second homes and investment properties. Conversely, they may prefer borrowers with substantial credit histories who plan to purchase a primary residence with more than 20% down.
Private Mortgage Insurance (PMI): PMI is an insurance policy purchased by borrowers who lack enough cash for a down payment on a mortgage. Since these borrowers are considered higher risks by lenders, they must pay an additional fee to cover potential losses in case of default.
Mortgage-Backed Securities: Government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac sell batches of conforming mortgages to investors in the secondary mortgage market, much like stocks do. The proceeds from these sales help fund these GSEs and enable them to offer more mortgages.
The GSEs also purchase mortgage-backed securities from lenders and bundle them for secondary sale. With the proceeds from these sales, these government-sponsored enterprises invest in more mortgages, increasing their portfolio.
Cash Reserves: Jumbo loans typically require borrowers to have several months or years worth of cash reserves on hand. The exact amount needed depends on several factors, including credit score, debt-to-income ratio, property type and occupancy status.
Furthermore, borrowers must demonstrate a high and steady source of income. Banks and other mortgage lenders are especially picky about applicants’ earnings because they cannot afford to lose a jumbo loan in case the borrower defaults. This requirement is especially crucial if investing in property is the goal.