When it comes to purchasing a home, there are two types of loans that borrowers typically consider: Jumbo and conventional mortgages. Both come with their own set of prerequisites including income parameters, credit ratings, and down payments. The main distinction between the two is that the former is common for high-value properties, while the latter tends to cater to more mainstream home buyers.
Private sector lenders underwrite both Jumbo and conventional loans. Thus, they do not have backing from government agencies like the Federal Housing Administration (FHA), the U.S. Department of Veterans Affairs (VA), or the USDA Rural Housing Service (RHS).
Jumbo loans usually finance high-priced properties, often reaching into millions of dollars. However, luxury properties and homes in competitive real estate markets are not the only acquirers of Jumbo mortgages. Some buyers with unique needs or wealthier purchasers pursuing an interest-only mortgage that culminates in one enormous balloon payment-where the total loan amount is due at the end-opt for Jumbo loans. These loans don't conform to the Federal Housing Finance Agency (FHFA) rules on size and value, effectively barring them from Fannie Mae or Freddie Mac support.
To successfully apply for a Jumbo loan, borrowers must present an exceptional credit score, occupy a high-income bracket, and possess a low debt-to-income (DTI) ratio. This is due to the fact that lenders take on a higher risk with Jumbo loans since federal agencies offer no backing, meaning borrowers may need to meet more stringent requirements.
On the other hand, conventional mortgages, often issued by banks, credit unions, and mortgage companies, aren’t federally subsidized. Unlike Jumbo mortgages, these loans could be conforming or nonconforming and are bound by underwriting guidelines of Fannie Mae and Freddie Mac. Conforming loans are revised every year according to FHFA rules and account for factors like a borrower’s credit score, DTI ratio, and loan size.
Should you be eyeing a lucrative property that goes beyond conventional loan limits, a jumbo loan could be your only viable option unless you can make a substantial down payment to bring the loan's value under the limit. Recent years have seen jumbo loans requiring a down payment of 15% to 20%, much higher than the 10% to 15% some conventional loans require, not to mention the low 3.5% allowed by FHA and other federal loans.
The possibility of paying a larger down payment isn’t the only financial sacrifice for jumbo borrowers. They’re expected to have superior credit scores (preferably above the 700 mark), lower debt ratios, and must possess sufficient liquid assets to cover a year’s worth of homeownership expenses-nearly double the requirement of conventional mortgage borrowers.
While comparing jumbo and conventional mortgages, one must bear individual factors in mind, such as your credit profile. The better it is, the lower your jumbo mortgage rate will likely be. Regardless of the loan size, interest rates primarily depend on Federal Reserve benchmarks and the borrower's credit score.
Ultimately, whether you opt for a jumbo or conventional mortgage, you must reflect on what you can comfortably afford. Factor in other financial goals such as retirement planning while considering your optimal loan size.