Understanding Conforming vs. Non-Conforming Loans
To understand jumbo loans, you first have to know about the two major players in the U.S. mortgage market: Fannie Mae and Freddie Mac. These government-sponsored enterprises (GSEs) provide stability and liquidity by purchasing mortgages from lenders. This frees up banks and credit unions to offer more loans to more homebuyers.
However, Fannie and Freddie operate under a specific set of rules. To manage their risk, they only buy mortgages that meet certain criteria, including the size of the loan. A loan that meets these standards is called a conforming loan.
The maximum size for these loans is the conforming loan limit, set annually by the Federal Housing Finance Agency (FHFA). For 2024, the conforming loan limit for most of the U.S. is $766,550 for a single-family home. In federally designated high-cost areas, this limit increases to $1,149,825. (Source: FHFA).
Any mortgage that exceeds these limits is, by definition, a jumbo loan. Since the lender can’t sell it to Fannie or Freddie, they must hold it in their own portfolio, making it a higher-risk investment for them.
How to Qualify for a Jumbo Loan
Because lenders assume more risk with a jumbo loan, they have stricter qualification standards. They need to be confident that the borrower has the financial stability to handle a large mortgage payment.
Here’s what lenders typically require:
- High Credit Score: While you might qualify for a conforming loan with a score in the 600s, jumbo loan applicants usually need a FICO score of 700 or higher.
- Large Down Payment: A down payment of at least 10% to 20% is standard for a jumbo loan, compared to the 3% to 5% minimums often seen with conforming loans.
- Low Debt-to-Income (DTI) Ratio: Lenders want to see that your total monthly debt payments (including your new mortgage) don’t consume too much of your gross monthly income. For a jumbo loan, a Debt-to-Income (DTI) ratio of 43% or lower is often required.
- Significant Cash Reserves: You must prove you have enough cash or liquid assets to cover a certain number of mortgage payments after you close. For jumbo loans, this could be anywhere from 6 to 18 months of payments.
Jumbo Loan vs. Conforming Loan: An Example
Let’s compare two scenarios:
- Scenario 1 (Conforming Loan): Maya is buying a home in Phoenix, Arizona, for $650,000. This amount is below the $766,550 conforming limit, so she can apply for a standard conforming mortgage with more flexible qualification requirements.
- Scenario 2 (Jumbo Loan): David wants to purchase a home in San Jose, California, for $1,600,000. This exceeds the high-cost area limit of $1,149,825, so he must seek a jumbo loan and meet the lender’s stricter financial criteria.
Is a Jumbo Loan Right for You?
Before pursuing a jumbo loan, consider the advantages and disadvantages.
Pros:
- Higher Loan Amounts: It allows you to finance a high-priced property with a single mortgage.
- Competitive Interest Rates: While once much higher, jumbo loan interest rates are now often competitive with conforming loans, as lenders compete for well-qualified, low-risk borrowers.
Cons:
- Difficult to Qualify For: The high credit score, low DTI, and large cash reserve requirements can be a significant barrier.
- Larger Down Payment: The need for a 10-20% down payment means you need more cash upfront.
- Manual Underwriting: The approval process is often more intensive and may take longer than for a conforming loan.
An Alternative to a Jumbo Loan
If you’re close to the conforming limit, a piggyback loan might help you avoid a jumbo mortgage. This involves taking out a conforming loan up to the local limit, and then a second, smaller loan—like a home equity loan or HELOC—to cover the remaining purchase price. This is often structured as an “80-10-10” loan (80% first mortgage, 10% second mortgage, 10% down payment).
Frequently Asked Questions (FAQ) About Jumbo Loans
1. Are interest rates on jumbo loans always higher?
Not anymore. Due to the strong financial profile of the typical jumbo borrower, these loans are considered less likely to default. As a result, lenders often offer very competitive interest rates that can be equal to or even slightly lower than those for conforming loans. (Source: CFPB).
2. What is the main challenge of getting a jumbo loan?
The biggest hurdle is meeting the strict qualification standards. Lenders look for excellent credit, a low DTI ratio, a substantial down payment, and significant cash reserves. Gathering the necessary documentation to prove your financial standing can also be a rigorous process.
3. Who needs a jumbo loan?
Jumbo loans are typically for homebuyers purchasing luxury properties or standard family homes in high-cost-of-living areas (HCOLAs) like San Francisco, New York City, or San Diego, where home prices regularly exceed the FHFA’s conforming loan limits.
To better understand your financial position before applying for any mortgage, explore our guides on managing your credit and debt.