If you are house hunting or own a home, you’ve probably heard about jumbo loans and conforming loans.
So what is the difference between a jumbo loan and a conforming loan?
Conforming Loans Meet Fannie and Freddie’s Guidelines
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 Federal Housing Finance Agency -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 is $417,000.
There are several ways a mortgage can earn the distinction of non-conforming. And if it is, Fannie and Freddie won’t touch it. The loan will need to be held on the originating bank’s books, or securitized with private capital.
Conforming Loans Rates are Lower
As a result, mortgage rates are generally lowest for loans at or below the traditional $417,000 loan limit, while loan amounts between $417,001 and $625,500, sometimes referred to as “high balance conforming” loan, will be slightly higher.
In San Diego County, conforming loan limits are staying at $417,000 for the traditional conforming mortgage and $546,250 for the San Diego high balance conforming program. Loans from $417,001 to $546,250 will have about a .25% higher interest rate and slightly more restrictive guidelines requiring higher FICO scores and lower debt to income ratios.
For true jumbo loans, you’re looking at even higher mortgage rates, depending on the type of loan and the lender’s risk appetite.
This all has to do with risk – because conforming loans are guaranteed by Fannie and Freddie, there’s more demand for them on the secondary mortgage market. After all, they’re essentially guaranteed by the U.S. 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 in conforming loans.
Jumbo Loans are More Expensive
Jumbo loans exceed the conforming loan limit, as mentioned above. That really is 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. Jumbo loans are riskier investments.
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.
Jumbo Loan Can be Difficult to Obtain
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 competing for your loan, you will likely discover higher interest rates and more financing restrictions in your loan.
For example, you’ll likely need to come up with a larger down payment – 20 percent or higher – while maintaining an excellent credit score. Lenders will also require a higher amount of assets.
Your loan program choices may also be more limited when seeking a jumbo. However, fixed-rate and ARM options are generally available.
These drawbacks explain why most home buyers attempt to avoid jumbo loans. You can either put down more cash at closing or go with a combo loan – first and second loan – which keeps the first mortgage below the conforming limit.
Be sure to shop around for rates and consult with a loan officer early in the process. You want to get your loan pre-approval in place before you start looking for homes.