Jumbo vs. Typical Mortgages: What is the Distinction?
Jumbo vs. Conventional Mortgages: An Overview
Jumbo and conventional mortgages are two types of financing that borrowers use for home purchases. Both require homeowners to meet certain eligibility requirements, including minimum creditworthiness, income thresholds, repayment ability, and minimum deposit requirements. Government Sponsored Corporations (GSEs) such as Fannie Mae and Freddie Mac, the Federal Housing Administration (FHA), the US Department of Veterans Affairs (VA), or the USDA Rural Housing Service do not endorse any of the mortgage products. Although they can be used for the same purpose – to secure a property – they are inherently different.
Jumbo mortgages are used to buy high-priced properties – often in the millions. Conventional mortgages, on the other hand, are more suited to the needs of the average homebuyer and may or may not be compliant. Read on to learn more about these two types of mortgage products.
The central theses
- Jumbo and conventional mortgages are two products borrowers use to secure real estate.
- Traditional mortgages may or may not be government guidelines.
- Jumbo mortgages tend to fall outside the appropriate credit limits, typically because they exceed the maximum amount secured by government sponsored companies like Fannie Mae or Freddie Mac.
As mentioned earlier, jumbo mortgages are loans that are used to finance home purchases. Unlike regular mortgages, these loans are intended for high-priced real estate. Luxury homes and those found in highly competitive local real estate markets are typically funded through jumbo mortgages.
These mortgages – also called jumbo loans – are not compliant. This means that they are outside the Federal Housing Finance Agency (FHFA) credit restrictions and therefore not endorsed by Fannie Mae or Freddie Mac. Even so, many still adhere to the qualifying mortgage guidelines set by the Consumer Financial Protection Bureau (CFPB). They also exceed the maximum compliant credit limit in their respective counties. Other factors that rule them out as compliant loans may include affluent borrowers with special needs or interest-only mortgages that culminate in balloon payments where the entire loan amount falls due at the end of the loan term.
To qualify for a jumbo loan, borrowers must have excellent credit ratings. Borrowers should also be in a higher income bracket. After all, it takes a lot of cash to keep up with regular mortgage payments and other related costs. And as lending requirements tightened after the financial crisis, borrowers are required to have a low debt-to-income ratio (DTI).
In the past, the interest on jumbo loans was significantly higher than the classic mortgage interest. Although the gap has closed, they are still a little higher. The requirements for down payments were also structured in a similar way – at times up to 30%. However, jumbo loans that require a down payment of around 10 to 15% are more common today. The higher interest and down payments of the past have usually been primarily used to offset the higher risk of these mortgage products as they are not guaranteed by the above GSEs.
Conventional mortgages are loans that are offered by private lenders such as banks and other financial institutions such as credit unions and mortgage lenders. Just like jumbo loans, borrowers require a down payment, a minimum credit rating, a certain income level and a low DTI rate and are also not supported by GSEs.
Unlike jumbo loans, conventional mortgages can be either compliant or non-compliant. Compliant loans are those whose limits are set by the FHFA. The underwriting guidelines for these loans are also set by Fannie Mae and Freddie Mac. In 2021, the national limit for compliant conventional loans is $ 548,250 for a single family home, down from $ 510,400 in 2020. However, more than 200 counties in the US are classified as high-cost, competitive areas with maximum credit limits Areas can go as high as $ 822,375 in 2021, down from $ 765,600 in 2020. New York City, Los Angeles, and Nantucket are some of these locations.
Adjusted credit limits are adjusted annually to keep pace with the average US house price so that as prices rise, credit limits increase by the same percentage.
However, not all mortgages comply with these guidelines, and those that do not are considered conventional non-compliant loans. These are usually more difficult to qualify than compliant mortgages as they are not government sponsored so eligibility and terms are left to the lenders to decide. One advantage is that they often cost less.
Fannie Mae and Freddie Mac will buy, package, and resell virtually any mortgage as long as it meets their respective credit guidelines. These guidelines take into account a borrower’s credit history and history, Debt to Income Ratio (DTI), Loan to Value Ratio (LTV) of the mortgage, and another key factor – the size of the loan. These maximum values are set by the government.
Since jumbo loans are not supported by federal agencies, lenders take a higher risk in offering them. You will face stricter credit requirements when trying to secure one. As mentioned above, there are a few minimum requirements that you must meet in order to qualify, including:
- Proof of income: Prepare yourself with two years of tax or similar papers to prove you have a reliable, steady source of income. Lenders also want you to have enough cash to cover mortgage payments for six months or more.
- Creditworthiness and History: In general, you need a credit score of at least 580 (as “fair”) before a lender will approve you for a 670 conventional mortgage.
- Debt-Income Ratio (DTI): Your debt-to-income ratio (your monthly debt versus your monthly income) should be 43 percent or less to qualify for a conventional mortgage. Lenders usually look for an even lower DTI for jumbo mortgages since the loans are so large.