What’s the Deal With Jumbo Loans

(Vitalii Vodolazskyi/Shutterstock)

One of the reasons that First Republic Bank failed was the abundance of low-interest jumbo loans they had outstanding. Jumbo loans or mortgages are riskier for banks to make.

But what are jumbo loans, and why are they risky? They may have been popular with the recently failed banks, but are they still common with other banks?

Jumbo Loans Explained

There are two types of home loans: a conventional conforming loan and a jumbo loan. According to the Federal Housing Finance Agency, in most counties, the maximum amount for a conforming loan in 2023 is $726,200. Any loan over that amount is considered a jumbo loan. The current jumbo loan amount was increased from 2022’s $647,2000 limit. But the limit varies by county.

Besides the loan size, there is another major difference between conforming and jumbo loans. Jumbo loans aren’t federally backed. They don’t come under Fannie May or Freddie Mac.

Risk of Jumbo Loans to Lenders

Fannie May and Freddie Mac buy a lender’s conforming loans. The stipulation to do this is that the loans must be written under Fannie May and Freddie Mac guidelines. These two government agencies are major purchasers of mortgages. Knowing that they can sell loans to Fannie May and Freddie Mac makes financial institutions issuing loans more comfortable.

But because jumbo loans aren’t backed by Fannie May or Freddie Mac, they are riskier for lenders. The government doesn’t guarantee these loans, meaning the lender has no protections if the borrower defaults.

And since jumbo loans are difficult, if not sometimes impossible, to resell, the lender takes on the full risk. That million-dollar jumbo home loan can hit a lender hard if the borrower defaults.

Jumbo Loan Rates

Although often a jumbo loan has traditionally had a higher interest rate than conforming loans, lately, this hasn’t necessarily been the case.

Jumbo loans can be very competitive with conforming loan rates. In fact, in 2022, some banks, like First Republic Bank, had jumbo loan rates lower than conforming rates.

Even Wells Fargo had lower rates for jumbo loans than for conforming loans. In December 2022, they had a 6.190 percent APR on a 30-year fixed-rate conforming loan. A jumbo loan, during that same period, had 5.473 percent for the same term.

Lenders’ Appetite for Jumbo Loans Diminished

The jumbo-conforming spread is the difference in rates between the two. With the latest economic turmoil and bank failures, this difference has begun to narrow. This is due to lenders losing interest and becoming more cautious when making jumbo loans. Bank liquidity is a concern.

At one point, rates for jumbo loans were lower than conforming loans. But that is changing. At the beginning of May 2023, the spread of jumbo to conforming loans was 13 basis points. But the spread was as far as 64 basis points in November 2022. A basis point is one-hundredth of a percentage point. In other words, 100 basis points equals one percent.

Need for Jumbo Loans

Whether you need a jumbo loan partly depends on your assets and credit. Jumbo mortgages are generally most used for those in the $250,00 to $500,000 income range. This income group is considered a “HENRY.” That stands for “high earners, not rich yet.”

A HENRY makes a lot of money but isn’t rich with millions yet.

But even though you qualify for a jumbo loan, it doesn’t necessarily mean you should take one out. This is especially true if you’re looking for a tax break.

Before December 14, 2017, anyone who had a maximum million-dollar mortgage could deduct the total interest if they itemized. But the Internal Revenue Service (IRS) changed the cap. Any home purchased after that date can only have interest up to $750,000 in mortgage debt deducted from their taxes. So, if you have that million-dollar mortgage, you can only deduct interest on the first $750,000. Depending on the state you live in, there will also be other deduction restrictions.

You’ll need to think and crunch the numbers before you go for that jumbo loan.

Qualifying for a Jumbo Loan

Although when qualifying, the procedures are the same for both a jumbo loan and a conforming loan, there are differences between the two.

You’ll need a 680 or better credit score, depending on the institution. A credit score on the lower end may earn you a higher interest rate.

A down payment of ten percent or higher will be required. If this is a second home, expect to pay higher. A debt-to-income (DTI) ratio will need to be 45 percent as opposed to the regular 50 percent. A DTI lets lenders know how much money you spend versus how much income you make.

You’ll need to show cash reserves to prove you can make large payments. The standard is six months. But a jumbo loan requires 12 months.

And since jumbo loans often go through a manual process, they can often take longer than a conventional loan.

Be prepared for higher closing costs with a jumbo loan.

Avoiding a Jumbo Loan

One way to avoid taking out a jumbo loan is to have a larger down payment. It could make up the difference and keep you in the conventional loan arena.

Another option may be to take a conforming loan plus a second loan. You’ll have two loan payments, but you won’t have to deal with jumping through hoops for a jumbo loan.

Jumbo Loans for Large Properties

If you’re looking to purchase a high-dollar home, you might want to consider a jumbo loan. But financial institutions are tightening up on this type of loan.

First Republic Bank and Silicon Valley Bank both failed, in part, due to low-interest jumbo loans. For a while, it was the Wild West when it came to issuing them. But jumbo loans aren’t federally backed, and private financial institutions must absorb any defaults.

The Epoch Times Copyright © 2022 The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.