A jumbo loan, also known as “jumbo mortgage”, is one type of financing that exceeds the Federal Housing Finance Agency's lending limits (FHFA). Jumbo loans cannot be purchased, guaranteed, or collateralized by Fannie Mae or Freddie Mac, unlike conventional mortgages. Designed to finance luxury properties as well as homes in highly competitive real estate markets, jumbo mortgages have unique underwriting requirements and tax consequences. As the housing market continues to recover from the Great Recession, these mortgages have become increasingly popular.

A jumbo mortgage's value differs from state as well as even by county. Annually, the FHFA determines the conforming loan limits for various regions. The limit for 2022 in the majority of the country was set at $647,200. This was a $98,950 increase from the $548,250 cap in 2021. The baseline limit for counties with higher home values is $970,800, or 150% of $647,200.

Loan limit calculations for areas outside the continental United States are governed by a different set of FHFA provisions. As a result, as of 2022, the baseline limit for a jumbo loan in Alaska, Guam, Hawaii, as well as the U.S. Virgin Islands will also be $970,800. In counties with a higher median home value, this amount could be even higher.

• A jumbo loan is a type of financing that exceeds the Federal Housing Finance Agency's established limits and cannot be purchased, guaranteed, or collateralized by Fannie Mae or Freddie Mac.

• Homeowners are subject to stricter credit requirements than applicants for conventional loans.

• Approval is contingent upon a high credit score and a low debt-to-income ratio.

• Typically, the average APR for jumbo mortgages is comparable to that of conventional mortgages, and down payments range between 10 and 15 percent of the purchase price.

What Is a Jumbo Mortgage Loan?

How Jumbo Loans Works

If you have your sights set on a home that costs close to or more than $500,000 and you don't have that much cash on hand, you will likely require a jumbo mortgage. And if you're seeking one, you'll be subject to much stricter credit requirements than homeowners applying for conventional loans. Since neither Fannie Mae nor Freddie Mac provide a guarantee for jumbo loans, the lender assumes a greater credit risk. There is also an increased risk because more money is at stake.

Similar to conventional mortgages, minimum requirements for jumbo loans have become more stringent since 2008. For approval, you will need a credit score of 700 or higher and a very low debt-to-income ratio (DTI). The DTI should be less than 43 percent, and preferably closer to 36 percent. Despite the fact that jumbo mortgages are nonconforming, they must still adhere to the Consumer Financial Protection Bureau's definition of a "qualified mortgage"—a lending system to standardized terms and rules, such as the 43% DTI.

If you prefer for a standard 30-year fixed-rate mortgage, you will be required to demonstrate that you have sufficient liquid assets to cover your payments, which will likely be substantial. Depending on the size of the overall loan, specific income levels and reserves are required, but all borrowers must provide 30 days of pay stubs and W2 tax forms dating back two years. Greater income requirements apply to self-employed individuals: Two years' worth of tax returns and at least sixty days' worth of bank statements. The borrower must also have liquid assets and cash reserves equal to six months of mortgage payments to qualify. In addition, all applicants must provide proper documentation on all other loans held and evidence of non-liquid asset ownership (like other real estate).

Jumbo Loan Rates

In the past, jumbo mortgages carried higher interest rates than conventional mortgages, but this disparity has narrowed in recent years. Today, the average annual percentage rate (APR) for jumbo mortgages is comparable to, and in some cases lower than, that of conventional mortgages. Wells Fargo, for example, billed an APR of 3.360% on a 30-year fixed-rate conforming loan and 3.065% on the same term for a jumbo loan as of January 1, 2022.

Despite the inability of government-sponsored enterprises to handle them, jumbo loans are frequently securitized by other financial institutions; since these securities carry greater risk, they trade at a yield premium relative to conventional mortgage-backed securities. However, the interest rates on the loans themselves have decreased the spread.

Down Payment for a Jumbo Loan

Fortunately, down payment requirements have become less stringent during the same time frame. In the past, jumbo mortgage lenders frequently required a 30% down payment (compared to 20% for conventional mortgages) from homebuyers. Now, this number ranges between 10% and 15%. As with any mortgage, there are numerous advantages to making a larger down payment, including avoiding the cost of the private mortgage insurance (PMI)required for down payments of less than 20%.

Who Should Obtain a Jumbo Loan?

Your ability to borrow ultimately depends on your assets, your credit score, and the value of the property you wish to purchase. These mortgages are deemed most suitable for a subset of high-income earners with annual incomes between $250,000 and $500,000. This segment is known as HENRY, which stands for high earners who are not yet wealthy. Essentially, these individuals earn a high income but have not yet amassed millions in extra cash or other assets.

While a member of the HENRY segment may not be wealthy enough to purchase an expensive new home with cash, these high-income individuals typically have higher credit scores and longer credit histories than the average home buyer seeking a conventional mortgage loan for a lower amount. They are also more likely to have well-established retirement accounts. Typically, they have contributed for a longer duration than lower-income earners.

Expect a modest tax deduction on a jumbo loan. For new mortgage debt, the mortgage interest deduction is capped at $750,000.

These are the kinds of individuals that financial institutions covet, in part because they frequently require additional wealth management services. In addition, it is more practical for a bank to manage a $2 million mortgage than 10 loans of $200,000 each.

Special Considerations for Jumbo Loan

You should not take out one of these loans simply because you may qualify for one. Certainly not if, for instance, you expect it to provide you with a substantial tax deduction.

You probably already know that you can deduct the mortgage interest you required to pay for any given year from your taxes if you itemize. The Tax Cuts and Jobs Act lowered the IRS's limit on this deduction, so you probably never had to worry about it. Those who obtained a mortgage on or before December 14, 2017 are eligible to deduct interest on up to $1 million in debt. For home purchases made after December 14, 2017, however, the mortgage interest deduction is limited to $750,000. If your mortgage is larger, your deduction is reduced. For instance, if you intend to obtain a $2 million jumbo mortgage that accrues $80,000 in interest per year, you can only deduct $30,000 in interest — the interest on the first $750,000 of your mortgage. In effect, only 37.5% of the mortgage interest is tax deductible.

This means you should borrow cautiously and calculate carefully to determine how much you can afford and what tax benefits you will receive. Now with state and local tax deduction limited to $10,000 per year, a highly taxed property will also cost you more to own due to the same tax bill. Compare loan terms to determine if taking out a smaller conforming loan plus a second loan, as opposed to a single large jumbo loan, would be better for your finances in the long run.

Other types of mortgages

FHA & VA loans

• Loans from the Federal Housing Administration and the Department of Veterans Affairs of the United States

• Low down payment options with adaptable credit and income standards

Fixed-rate mortgages

• Your interest rate remains constant throughout the life of the loan

• Your monthly principal and interest payment does not change during the life of the loan

Adjustable Rate Mortgages (ARMs)

• In Adjustable rate mortgage, the interest rate may fluctuate periodically over the life of the loan

• Your monthly payment may increase or decrease in response to interest rate changes

Affordable Loan Solution Alternative

• Minimum down payment of 3%

• Income restrictions