Securing a home loan can be tough in any market, but if you’re hoping to buy in a location where real estate prices really soar (San Francisco and New York City, we’re looking at you), it can be even more difficult.
Normally, lenders won’t provide loans to borrowers if they don’t meet the conforming loan limits set by Fannie Mae. For single-family homes, that means financial institutions won’t lend more than $417,000 on a mortgage. (The number is higher for homes in Alaska, Guam, Hawaii, and the U.S. Virgin Islands.)
Enter the jumbo loan. If you’re looking to borrow more than the conforming loan limits allow — and you have a strong credit score with a low debt-to-income ratio — a lender may suggest a jumbo loan as an option.
But proceed with caution: There are a number of reasons to avoid jumbo loans if you can.
1. More lenders to choose from
One of the biggest reasons to stick with a loan that conforms to the set limits: You simply have more options when it comes to choosing the best lender for you. Jumbo loans present more of a risk than loans that conform to Fannie Mae’s limits.
As a result, the government agency won’t buy jumbo-loan mortgages from the lenders that made them — which means more of the bank’s own capital is at risk if a borrower fails to pay their mortgage.
2. Jumbo loans are pricier
More lenders to choose from means more competitive pricing — and that, in turn, means better interest rates for borrowers. “Interest rates are lower on conforming loans due to higher competition and the ability of the lender to sell the mortgage to government-backed entities,” says Lee Huff of Bald Finance.
According to a survey by Bankrate, the interest rates on jumbo loans do follow the trend of being higher than loans made for less than $417,000. Survey respondents reported that on fixed-rate, 30-year mortgages that conformed to Fannie Mae’s limits, the average rate was 4.11%. Jumbo loans, however, ran an average of 4.63%. And every sliver of a percentage point makes a difference, especially when you’re looking at large loan amounts.
3. A jumbo loan isn’t easy to get
As if the home-buying process weren’t stressful enough, taking out a jumbo loan may mean extra requirements have to be fulfilled before you can secure the mortgage. “Sometimes lenders can require two appraisals due to the values of higher-end homes being more subjective,” says Deacon Hayes of Well Kept Wallet.
“Houses that are more expensive tend to have less comparable sales on which to value a home,” Hayes explains. “Because of this, a lender wants to make sure to value the home appropriately and therefore will often get more than one appraisal to get an accurate picture of what a home is worth.”
Ultimately, if you have the choice, it’s probably a good idea to avoid a jumbo loan. Not only are conforming loans offered by more lenders and tend to allow for lower interest rates, but avoiding a jumbo loan means less money you’ll have to pay back over time — which is always a good thing for the health of your personal finances.