What is a jumbo loan?

If you’re shopping for a house and need to take out a large mortgage, you may turn to a jumbo loan.

A jumbo loan is a mortgage for an amount larger than the limit set by the Federal Housing Finance Agency, or FHFA. This limit is the maximum size that a mortgage can be in most parts of the U.S. to qualify for a guarantee from Fannie Mae or Freddie Mac.

Each year, the FHFA updates the guidelines that determine what size mortgages are classified as jumbo loans. In 2021, jumbo loans are typically mortgages larger than $548,250. 

• How do jumbo loans work?
• Is a jumbo loan a good idea?
• What down payment do I need for a jumbo loan?
• What’s next: How much home can I afford?

How do jumbo loans work?

To understand jumbo loans, it helps to understand a bit about conforming loans.

Conforming loans are mortgages for amounts less than the limits set by the Federal Housing Finance Agency that are governed by regulations from Fannie Mae or Freddie Mac. Fannie Mae and Freddie Mac buy conforming loans from lenders to help lenders maintain cash flow and keep the mortgage market stable.

Conforming loans typically have to be smaller than the baseline limit set by the FHFA. Mortgages that exceed these amounts are called jumbo loans.

How much can I borrow with a jumbo loan?

Jumbo loans are typically mortgages of more than $548,250 in 2021, depending on the area where the house is located. In high-cost areas such as Alaska, Hawaii, Guam and the U.S. Virgin Islands, jumbo loans are larger than $822,375 for one-unit properties.

You can find lenders that offer jumbo loans of more than $1 million. Typically, lenders will only offer you this type of loan if you have strong credit and a sizeable down payment.

What’s the difference between a jumbo loan and a conventional loan?

A conventional loan is a loan from a private lender that isn’t backed by a government program.

A jumbo loan can be a conventional loan, or it can be part of a government program like an FHA loan.

Is a jumbo loan a good idea?

Whether a jumbo home loan is a good idea for you depends on your financial situation. Keep in mind that qualifying for a large loan doesn’t necessarily mean it’s a wise choice to borrow that amount.

Jumbo loans can be expensive, and lenders may view jumbo loans as riskier than smaller mortgages. That’s probably at least partly because they aren’t guaranteed by Fannie Mae or Freddie Mac. Plus, when a mortgage is large, even small drops in home value could put the lender at risk. After all, a 10% drop in home values will make a smaller dent in the value of a $100,000 home than a $1 million home.

And lenders may charge higher interest rates on jumbo mortgage loans because of the perceived higher risk.

As with any mortgage you’re considering, it’s best to think about whether you’ll be able to afford the monthly payments while leaving room for other expenses, including home maintenance. You may find that you need to budget more for upkeep on a large, expensive property than you would on a less costly house.

Also, you’ll likely want to make sure that you’ll still have money left over to meet your savings and retirement contribution goals after you make your monthly housing payments. Buying a larger house shouldn’t be a substitute for meeting your savings goals.

What down payment do I need for a jumbo loan?

You typically need a down payment of at least 3% to 5% to get a mortgage. But a lender may require a higher down payment for jumbo loans. The down payment requirement varies by lender, but it could be 20% of the purchase price or higher.

Even if your lender doesn’t require a 20% down payment, it’s still a good idea to make a down payment of that size if you can. Putting 20% down gives you meaningful equity in your home at the start of your mortgage and could give you some protection if the value of the home decreases. Building equity with a large down payment could also make it less likely that you’ll end up with an underwater mortgage, which is when the amount you owe on your home loan is greater than your home’s market value.

Because jumbo loans are large, being underwater on a jumbo loan could mean owing a significant amount of money over the home’s market price. If you aren’t able to pay back the full amount, you might be unable to sell the house unless its price rises.

What’s next: How much home can I afford?

To see if a jumbo mortgage would fit in your budget, find out what your total monthly payment would be. You can use online tools like the home affordability calculator from Freddie Mac to estimate the sum of your principal and interest payments, plus other costs such as homeowner’s insurance, property taxes and homeowner’s association fees.

Compare this monthly housing payment with your monthly income before taxes. A general expectation in mortgage lending is that borrowers will spend no more than 28% of their monthly gross income on housing.

Looking at your debt-to-income ratio can give you more insight into whether a jumbo mortgage is affordable for you. To calculate it, add your monthly long-term debt payments to your monthly housing payment. Then, divide the result by your monthly income before taxes — a rule of thumb is that this number shouldn’t be more than 36%.

If you decide that a jumbo loan makes sense for you, start getting your finances ready to apply for a mortgage. Request a copy of your credit reports, and check your credit scores. Collect the documents you’ll need for an application, such as signed federal tax returns from the past two years, personal identification, and recent pay stubs and bank statements.