The jumbo loan vs conventional loan conversation is one that every buyer should have with a reputable agent, especially if the properties that are being considered are on the cusp of the two types. There are many differences between the jumbo and the conventional loan, and you should know the major differences before you commit to one or the other as a loan program
What is a conventional loan?
AÂ conventional loan is also known as a plain vanilla loan. When compared to the bureaucracy of other government sponsored loans and even to the jumbo loan, the conventional loan is simple and straightforward. Its limitations, minimums, and requirements are oftentimes used as benchmarks for the market and for other types of loans.
In order to be classified as a conventional loan, a loan may not be backed by a government agency like the Federal Housing Administration (FHA) or the United States Department of Housing and Urban Development (HUD). This helps to differentiate the conventional loan from other loans under these programs with similar terms but different minimum requirements and application procedures.
What are the normal terms and conditions of a conventional loan?
Conventional loans are usually given for a term between 10 and 30 years. They apply to properties that require less than a $417,000 loan to purchase except in certain high value real estate markets such as New York, where the limit is raised to $723,000. These limits are raised periodically with inflation.
Borrowers will need excellent credit, usually defined as a credit score over 700 and a history of up to date payments, in order to qualify for a conventional loan. The 30 year mortgage interest rate on a conventional loan is the most often quoted benchmark by media outlets as the normal rate for a mortgage. Potential borrowers will also need a verified income that is consistent and adequate to justify the risk. In some cases, lenders will also check the cash that a borrower has on hand, although the only industry standard requirement that a borrower is usually held to is a 20 percent down payment upfront.
What is a jumbo loan?
A jumbo loan is defined in oppositional terms from a conventional loan. The main criteria that a loan requires in order to be a jumbo loan is relief of the $417,000/$723,000 loan limit that conventional loans implement. The amount that a borrower can have under a jumbo loan is limited only by the private agreement between the lender and the borrower.
What are the normal terms and conditions of a jumbo loan?
People who are looking to purchase a piece of real estate with a jumbo loan are held to an even higher level of scrutiny than those applying for a conventional loan. Many people believe that this is solely because of the higher amount of money that is being borrowed, but this is only a part of the reason. Lending institutions sell mortgages on the secondary market to other lenders, and jumbo loans are harder to sell. Lenders like to compensate themselves for the extra time and marketing that it takes to unload jumbo loan securities.
A borrower will usually need a credit score of at least 700 with a solid record of payments to creditors in order to qualify for a jumbo loan. Lenders give the best terms to people with credit scores above 740. During the jumbo loan application process, lenders are also more prone to look at other metrics that showcase the level of financial readiness of the borrower such as the debt to income ratio, the debt to value ratio after the down payment, borrower cash on hand, and liabilities of the borrower. For instance, keeping the debt to income ratio below 30 percent will likely help you as a borrower to secure a jumbo loan.
Should I use a jumbo loan or a conventional loan?
There are many tools that a savvy real estate investor uses in order to minimize interest payments and risk. When it comes to the jumbo loan versus the conventional loan, the general argument is that you should stay below the conventional loan level when you can because of the lower interest rates and decreased scrutiny. However, many properties just cost more than $417,000.
For instance, In order to stay below conventional loan limits for a $500,000, a savvy buyer may take a combination loan instead of a jumbo loan. A combination loan splits the mortgage for the property into two loans, both under the conventional loan limit. Instead of a single jumbo loan for $500,00 at 8.25 percent, a borrower takes out two loans, one for $350,000 at 7.25 percent and another for $150,000 at 6.75 percent. The result is a lower interest rate, lower monthly payments, and an easier application process, depending on the lender.
However, there are some properties that simply require a jumbo loan. For instance, a $2.5 million property is much easier to pay as a single loan rather than splitting it into 10 $250,000 loans. Most lenders will not allow you to do this unless you have impeccable credit, cash enough to cover a huge down payment and an emergency fund, and plenty of previous transactions that went perfectly.
2 Point Highlight
During the jumbo loan application process, lenders are also more prone to look at other metrics that showcase the level of financial readiness of the borrower such as the debt to income ratio, the debt to value ratio after the down payment, borrower cash on hand, and liabilities of the borrower.
For instance, In order to stay below conventional loan limits for a $500,000, a savvy buyer may take a combination loan instead of a jumbo loan.
