A home purchase is probably one of the most significant expenses most Americans experience in their lifetime. Only a few people can afford to buy it in cash, and the rest of us have to borrow the money. Different types of lenders invest their money into homebuyers’ properties, but the is one difference that divides all loans into two categories: loans issued by private lenders and government loans.
Technically, all loans issued by private lenders are called conventional mortgages – and jumbo loans are a part of that group. However, in this article, we will explain how jumbos are different from the rest of the conventional loans. Not only that there differences between conventional and jumbo loans, but there are also significant differences between the “perfect applicants” for each type.
What is a Conventional Loan?
Conventional or regular loans are a group of mortgages issued by private lenders to borrowers with average or above-average credit scores. Nevertheless, in this article, we will make another categorization. All loans issued by private lenders can be classified as either conforming or non-conforming loans. Those loans that are conforming we will be calling conventional or regular loans.
Now you might be wondering: “Conforming to what?” – and that is a valid question. There are mortgage guidelines created by the Federal Housing Finance Agency, Fannie Mae, and Freddie Mac, that regulate some properties of the loans. If the loan conforms to those regulations, it can be securitized by these government entities.
These guidelines refer to things such as the applicant’s credit score, minimum down payment, and the amount of the loan. Of course, not every state has the same regulations, for example, California’s conventional loans will not be the same as conventional loans in Missouri.
So, regular or conventional loans are conforming to those guidelines and are, therefore, securitized by Freddie Mac or Fannie Mae. Conventional loans have stricter criteria for the borrowers, you need to have a larger down payment and a lower debt-to-income ratio. However, these types of loans are the most popular on the mortgage market, because they have the lowest long-term costs of home-ownership.
The biggest upside that conventional loans have over government-issued loans is that you usually don’t need to pay mortgage insurance premiums. The biggest downside is that borrowers usually need their credit score to be over 620.
What Are Jumbo Loans?
Jumbo loans are a non-conforming type of property financing, used for purchasing luxury real estate. Jumbos are surpassing the regulated amount set by Federal Housing Finance Agency, and are, therefore, not viable for securitization by Fannie Mae and Freddie Mac. Lenders are taking a big risk when giving you a jumbo loan, so they cover that risk by setting a higher interest rate.
Let’s say you are a high-earner but have not yet been able to save up enough, and you need a loan to buy a property. The houses in your price range are making it impossible for you to take a conventional loan because you can’t borrow more than $647,000. You are then looking for alternative ways to finance your purchase.
Jumbo loans are larger than $647,000 and can go up to a few million dollars. You can take a jumbo for any kind of property, whether it’s a primary residence, vacation home, or investment property. The lender sets the interest rate depending on your credit score, type of property, and loan length.
You can take a fixed rate and pay for 30 or 15 years, or take an adjustable rate, which means you pay a fixed rate for 5-7 years, after which the rate changes and there isn’t a set length. Down payment will also depend on the length of a loan and the property type, but the minimum down payment for a 30-year jumbo on a primary residence is usually 20%, although there are lenders that allow 15% if your credit score is high enough.
Of course, many criteria will depend on the lender, but usually, the bare minimum you need to have as a jumbo loan applicant is a credit score of at least 680 and a debt-to-income ratio lower than 45%.
Key Differences Between Conventional and Jumbo Loans
Now that we established what they are, it is time to compare conventional and jumbo loans. Let’s start with similarities. Both are issued by private lenders and are available for all types of properties. By paying a minimum of 20% down payment, you don’t have to pay mortgage insurance premiums for either of these loans.
However, while conventional loans have a maximum limit, jumbos have a minimum – and that limit is adjusted accordingly, depending on the market situation. Right now, that limit is set at $647,000. And, while conventional loans are available to many Americans, jumbos are reserved for high-earners with higher credit scores.
The minimum credit score allowed for a conventional loan is 620, while jumbos require at least 680, but the limit can get up to 760 depending on various factors. Debt to income ratio is similar, lenders will ask for a DTI lower than 48% for a conventional, and lower than 45% for a jumbo loan.
Down payment is similar in percentage, which is between 15-20% minimum. However, the amount of money is much higher for a jumbo since those properties are often valued at $900,000 or more. Let’s not forget that luxury properties have a median price higher than $1,200,000.
Of course, an additional difference is the mortgage rate, but it is the ever-changing loan property, not only because of the market fluctuations but also because lenders can decide based on the borrower’s qualifications. For example, during the record-low mortgage rates in 2021, the same borrower could take 2.65% on a conventional mortgage or 3.5% on a jumbo loan.
How to Choose a Lender if You Want a Jumbo Loan
Jumbo loans are a risk to the lender, that is why some of them set much higher standards and interest rates when offering jumbos to you. For this reason, it is smart to pay extra attention and time to find the right lender, because it could save you thousands of dollars. It is important to be realistic about the properties that are offered to you, but also not to agree to anything without checking what the competition is proposing.
Which Loan is Better?
There is no definite answer to the question of Jumbo loan vs Conventional Mortgage because it will always depend on your unique borrowing situation and financial abilities. If you want to buy a luxury property, a conventional loan will not be helpful unless you have a lot of money saved for a down payment. However, if you want to buy a medium-range property, jumbo loans will only add unnecessary homeowning costs.
Decide on a loan by considering not only what you can afford at this moment, but also what is sustainable for you in the long run. After all, a mortgage is something that stays on your credit for a long time and you don’t want to default or endanger your credit score in any way.