The Negatives of a Jumbo Home Loan
A jumbo home loan is any loan that exceeds the conforming loan limits set by Fannie Mae and Freddie Mac, two government-affiliated mortgage agencies. Currently, any loan in excess of $417,000 is considered to be a jumbo loan (except in areas considered as high cost, which have separate loan limits; visit www.fanniemae.com/aboutfm/loanlimits.jhtml to see a complete list of limits). The homes requiring this type of loan used to be considered luxury homes, but in today's market even modest homes have price tags in this range. Even though a jumbo loan may be necessary, they do have many negative factors that you should consider before buying property requiring one.
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Higher Interest Rate
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The interest rate for a jumbo home loan is usually a quarter to a full percent higher than a conventional loan (to see current jumbo loan rates, visit www.mortgageloan.com/jumbo-mortgages). This seems to be unfair to the jumbo borrower, but for the mortgage lender it makes the loan more profitable. Here is why.
Fannie Mae and Freddie Mac are the ones who market the majority of the mortgages in the United States. Typically, residential loans are purchased by these agencies and then packaged together to be traded in the financial market, similar to stocks. Many investors shy away from jumbo loans because of their higher risk. The increased interest rate, however, makes them more enticing to investors, since they will be more profitable.
Higher Risk
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Jumbo loans pose a higher risk for the lender than conventional loans. This is why there are negative factors for the borrower, to help to minimize the risk to the lender. The largest risk factor for the lender is the fact that higher-priced properties are harder to sell quickly for full price, so if the borrower defaults on the loan, the lender will have a more difficult time recovering the entire loan amount.
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Higher Down Payment
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Because of the inherent risk associated with jumbo loans, most lenders will require a higher down payment. The loan options for jumbo loans is similar to those for conventional loans, but most will require about 5 percent higher down payment than what would be required for a conventional loan. In addition, jumbo loans do not have the option of zero down payments.
Higher Cost of Refinancing
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If a jumbo loan holder finds himself in a position of needing to refinance, the cost to do so will be higher than for a conventional loan. The closing costs for a jumbo loan are high because the mortgage tax amount is factored from the amount of principal (or loan amount).
Avoid the Jumbo Loan
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Even for those buying a higher-priced home that requires a jumbo loan, there are some options to avoid the higher interest and risks associated with jumbo loans. An 80/20 loan option allows for two loans, a secondary loan taken for 20 percent of the total principal value and the primary loan for the other 80 percent. With 20 percent taken out of the total, the remaining balance will then be under the loan limit, allowing for a conventional loan.
If you cannot get an 80/20 loan, there is still a way to avoid the high price that Primary Mortgage Insurance incurs (this is insurance that all borrowers must pay if their loan-to-value ratio is higher than 80 percent). Some lenders offer a Lender Paid Mortgage Insurance program, which builds the insurance premium into the interest rate. This means that you may pay a little higher interest rate, but you will avoid the high insurance premium that can increase the monthly payment beyond your means.
For those refinancing, there are title companies that offer a 50 percent discount on the refinance of a jumbo loan, thereby alleviating the high closing costs.
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