Let’s pretend that, over the years, you’ve become a self-made person and are now ready to buy the property of your dreams. You want to go for a house in an affluent neighborhood, but you also don’t want to buy it in cash. This way, you still have better control over your cash flow.
Instead, you want to apply for a mortgage. But the amount you need to borrow is too large for a conforming home loan. What do you do? You can apply for a jumbo mortgage.
What Is a Jumbo Mortgage?
A jumbo mortgage is a home loan that exceeds the conforming limit of $510,400 (as of 2020) in most areas or exceeds the purchase price. Jumbo mortgages are backed by Fannie Mae and Freddie Mac using private lenders and investment groups.
In other words, jumbo home loans can now allow you to access more homes, especially if you have enough money to spare and you want to ease out competition from other home buyers looking for a conventional mortgage.
Jumbo loans usually have competitive rates, and sometimes they are lower than those available for smaller loans. In some cases, jumbo mortgages can be more easily financed because lenders consider them less risky given their larger size and better collateral protection. Lastly, a borrower might be able to purchase a home with little or no money down.
How Does a Jumbo Loan Work?
Jumbo loans are generally used by high-net-worth individuals seeking large amounts of cash to finance a property below market rates. The key benefit to this type of loan is its competitive pricing structure, which allows borrowers to finance the purchase of a home while putting little or no money down.
The loan amounts are generally too large for conventional financing options. Still, they can be used by borrowers to leverage their investments and take advantage of capital gains in real estate markets and other investment vehicles.
Jumbo mortgage loans typically have fixed-rate interest, just like smaller mortgages. This is because lenders that offer these loans prefer that they be repaid over a longer period. At this point, the principal amount paid back will exceed the original value of the collateral loaned against. It also assumes adequate equity in the subject property purchased using funds borrowed through this type of loan to secure it properly. Lenders will only offer this type of loan on a case-by-case basis.
Things to Consider
However, jumbo mortgages also come with some caveats that every buyer needs to know. Before you even ink that contract, know the following:
1. Down Payment
Jumbo mortgages still require a 20 percent down payment, but the amount is often sizable. If you plan to use all your savings for the down payment, don’t forget that once you close on the home, you’ll need money each month for insurance premiums, maintenance, and taxes. That’s why it would be wise to make sure you can cover these items with cash flow from the property.
The same thing goes if you expect to finance some of these costs with a second mortgage or tap into personal credit lines. If your total debt service eats up too large a percentage of your monthly income, you might not have enough left over to make the minimum payments on both your new mortgage and your other debts.
2. Closing Costs
Your closing costs are likely to be higher when borrowing through a jumbo mortgage since it takes many lenders longer to underwrite their risk with these loans. In addition, some lenders charge more for using “non-FHA” mortgages because they include additional paperwork and require that appraisals go higher than what is normally required by FHA guidelines.
The total fees generally run from 2 up to 3 percent of the total loan amount, depending on whether you obtain conventional financing or use an FHA mortgage. If you borrow $200,000 on a jumbo mortgage, expect to spend an additional $4,000 to $8,000 in closing costs alone.
Also, consider the fact that these larger loans usually require more paperwork than smaller ones. That means you’ll likely need to pay your attorney and title company by the hour instead of being able to negotiate flat fees per transaction.
Most real estate investors are pretty savvy when it comes time for negotiating their deals. However, don’t be overly confident in thinking you can do this with attorneys as well. When dealing with large transactions at times, negotiators “burn up the phone lines” between particular parties and will end up charging four or five figures in legal fees. You think twice about paying these fees for attorneys and title companies when you can avoid them.
3. Homeownership Expenses
You’re probably going to pay more for the house. With traditional loans, there is usually a cap on how much more someone can pay in interest and fees because of how loan amounts are linked to property values.
However, jumbo mortgages don’t follow this rule. If your loan amount exceeds $510,200, then it’s likely that you’ll end up paying less for the home itself than someone with a conventional down payment over 15 percent would pay.
Jumbo loans aren’t for everyone, but they’re a great tool for those who want to maximize the appreciation of their assets or real estate investments and get their hands on more precious properties in the market.
