A “jumbo” loan (also known as a “non-conforming” loan) speaks to the dollar amount of the loan you are seeking. It means the loan does NOT “conform” to standard Fannie and Freddie mortgage purchasing limits.
Fannie and Freddie are Government Sponsored Enterprises (GSEs) which purchase loans that are “conforming” to federal standards, generally under $417,000. While most loans over $417,000 are considered “jumbo” in most parts of the country, there are certain higher wealth counties In America in which the jumbo loan threshold only starts at $625,500.
The jumbo loan marketplace is riskier because the government does not back non-conforming loans; that risk is solely taken by the lender him or herself. This oftentimes makes these loans higher priced than conventional loan counterparts. Think simply… more risk, higher price. In our experience, FDIC-insured banks are the most competitive in the jumbo loan marketplace… and for good reason. FDIC-insured banks want these clients very badly. They are typically higher net worth people whom these banks want to sell their family of services to: merchant services, private wealth management, and so on. These banks are willing to take the “risk” in exchange for having these higher net worth people in their bank.
The Federal Housing Finance Agency (FHFA) sets the rules about what is conforming and non-conforming throughout the country. They do this by compiling house closing data from across the country. The data that is compiled is called the House Price Index (HPI). The HPI takes into account the area each house is in and weighs it relative to other homes in the area. While not perfect, it provides a somewhat fair basis for setting the loan criteria. So, high cost areas like San Jose, NYC, SF, and Santa Barbara will have jumbos in excess of roughly $625,000 while the further you move away from a city, especially outside of California, you will see the $417,000 number as the limit.
As you may know, most loans in America are FHA or VA and thus backed (insured) by the government. Whether done by mortgage brokers, banks, or direct lenders (private lenders), these loans are typically sold to the aforementioned Government Sponsored Enterprises (GSEs), like Fannie Mae and Freddie Mac. These private lenders rely of Fannie and Freddie to purchase the loans that they make. And, Fannie and Freddie do not purchase loans greater than $400,000.
Thus, loans over $400,000 are typically done by the large FDIC-insured banks. These banks generally keep the loan and service it (collect payments) themselves. There is more risk involved with this because the government is not backing (purchasing) these mortgages. The government stays out of this marketplace because it knows the FDIC-insured lenders can handle the risk and, perhaps more importantly, they know these banks want these higher net worth people banking with them.
In the jumbo loan space, banks typically want twenty percent down payment to make sure the borrower has skin (cash) in the game. The banks mitigate their risk by making the borrowers credit score threshold higher (typically 680 and above) and the debt to income ratio no more than 38%. What is very important to understand is that each bank, individually, sets their own criteria for jumbo loans. We have found that some banks are more aggressive in the marketplace than others and their aggressiveness can change as frequently as what quarter of the business cycle they are in.
The pricing on a jumbo loan is typically higher than conventional loans by a half or quarter point simply because there is greater risk. Think of the risk like this:
1. On a conventional, or conforming loan, (under $417,000) there is a much larger pool of potential buyers should someone stop making payments on that mortgage. That is to say, the lender can sell (or liquidate) that mortgage and recoup their costs faster than they could on a jumbo loan, where the number of potential buyers is much smaller. It really is that simple of a math problem. 2. Jumbo loans are not insured by the government like a conforming loan is typically. More risk, higher pricing. Very simple. 3. The loan can’t be sold off to a Government Sponsored Enterprise like Fannie Mae or Freddie Mac because they are non-conforming (over $417,000) and GSEs will not insure loans over that threshold. Again, more risk (no insured fall back if the mortgage fails), higher pricing.
A borrower would never request a jumbo loan; you either are or you are not. In fact, many people try not to be in the jumbo arena by putting either more money as a down payment or by finding a home specifically under the roughly $625,000 threshold. Short of finding a cheaper home, the only way to truly avoid a jumbo is by giving the lender more money so that you do not qualify for the “jumbo” rate. In this case, you are buying the risk out of the equation. The calculation one must do is simple: could I get a better return on the money I would use to buy down the mortgage versus the benefit, tax and otherwise, I would receive by paying the higher rate? This equation is unique to each borrower and his/her risk tolerance and tax strategy.
Our advice to potential jumbo loan borrowers is that the banks want you (your deposits) and your business. You must think of yourself as an asset that these banks are trying to find. It is difficult to find responsible citizens who will not have trouble paying back their mortgage. If you are one of those borrowers, then you are an asset to any lender. Your assets in their bank is what they want. Deposits are a huge asset to any bank. The simple math can be done by looking at your bank statement and see what percentage of interest you are making on your deposits. And with you in their bank, they can offer and try to cross sell you any number of products under in their banking family.
Jumbo loans are a gateway to getting the right clientele in their bank.