Today we’ll look at another common mortgage match-up: “Jumbo loans vs. conforming loans.”
If you currently have a mortgage, or have been shopping for a mortgage, you’ve probably heard plenty about both jumbo loans and conforming loans.
So what’s the difference between the two, you ask? And does it matter?
Conforming Loans Meet Fannie and Freddie’s Guidelines
Well, for starters, a conforming loan is a mortgage that meets the underwriting guidelines (credit, income, assets requirements) of Fannie Mae and Freddie Mac, the government-backed pair that buy and securitize mortgages on the secondary market.
Additionally, the loan amount must be at or below the conforming loan limit (set by the FHFA) to be considered conforming.
This limit was as high as $729,750 in the highest-cost regions of the United States, but on October 1, 2011 it dropped to a maximum of $625,500, and the traditional conforming loan limit was a much lower $417,000.
In 2017, these numbers increased to $636,150 and $424,100, respectively.
Confused yet? You should be, considering the conforming loan limit has been messed with a lot ever since the mortgage crisis unfolded.
But the takeaway here is that conforming loans are smaller in size than jumbo loans, as the name implies. That’s pretty much the point to remember.
While there are several ways a mortgage can earn the distinction of non-conforming, only a large loan amount will make it a jumbo. And if it is, Fannie and Freddie won’t want anything to do with it, and it will need to be held on the originating bank’s books, or securitized with private capital.
Mortgage Rates Are Cheaper for Conforming Loans
As a result, mortgage rates are generally lowest for loans at or below the traditional $424,100 loan limit, while loan amounts between $424,101 and $636,150, known in some circles as conforming jumbo loans, will be slightly higher.
For outright jumbo loans, you’re looking at even higher mortgage rates, depending on the type of loan and the issuing lender’s risk appetite.
This all has to do with risk – because conforming loans are guaranteed by Fannie and Freddie (who are government-owned), there’s more demand for them on the secondary mortgage market. After all, they’re essentially guaranteed by the government.
As a result, interest rates will be lower because more buyers means banks can fetch a higher price for their mortgages, and thus offer a lower yield, which corresponds with a lower mortgage rate for Joe Consumer.
Jumbo Loans Tend to Be Priced Higher
Then are are jumbo loans, which are mortgages that exceed the conforming loan limit, as I mentioned above. That’s pretty much the only determining factor.
Because they don’t adhere to Fannie and Freddie’s standards, they don’t come with that sought-after government guarantee. This means a jumbo loan is a conventional loan.
And so mortgage rates on jumbo loans will be higher – how much higher depends on the market. If investor demand for jumbos is strong, the rate spread may be narrow, and vice versa.
Historically, the spread has only been a quarter to a half percentage point, but it widened to as much as two percentage points during the height of the financial crisis, seeing that nobody wanted to touch anything without an implied government guarantee.
Currently, the spread between conforming and jumbo loans is less than half a percentage point. But it’s not just higher mortgage rates you have to worry about with a jumbo loan.
Getting a Jumbo Loan Can Be More Difficult
Qualifying for a jumbo loan is also much more difficult than qualifying for a conforming loan, as fewer banks and mortgage lenders offer them. With a smaller number of banks vying for your loan, you will likely be greeted with both a higher interest rate and more financing restrictions.
For example, you’ll likely need to come up with a larger down payment (we’re talking 20 percent and higher) while maintaining an excellent credit score. Plenty of assets are usually a requirement as well.
However, these drawbacks explain why most homebuyers attempt to avoid jumbo loan territory, either by putting down more cash at closing or going with a combo loan, thereby keeping the first mortgage below the conforming limit.
In any case, be sure to shop around with a large numbers of lenders to ensure you explore all your options, whether your loan is conforming, jumbo, or somewhere in between.