Jumbo vs. conventional loan: What's the difference?
Jan. 31, 2020 • 7 min read
What we'll cover
Who qualifies for a jumbo loan
The costs of a jumbo loan
How interest rates factor in
When shopping for new shoes, it’s all about finding that perfect fit. You don't want to go too small and squash your toes. Pick a pair that’s too big, and you’ll walk right out of them. You need something that's just right. It’s the same idea when you’re shopping for a home … just on a much larger scale.
Like with shoes, mortgages aren’t one-size-fits-all — so, let’s compare jumbo vs. conventional loans to help you figure out which type fits you best.
It can be tricky deciding which mortgage loan to select, especially for first-time homebuyers who are still learning the basics of borrowing. If you're ready to try on a home loan for size, here's what you need to know about jumbo vs. conventional loans.
Conventional loan basics
Conventional mortgages are probably what first come to mind when you think about mortgage loans. In a nutshell, a conventional loan is any loan that is not insured or backed by the government in any way. So, FHA or VA loans, for example, aren't conventional mortgages, since those loans are supported by government programs.
A conventional loan can be a conforming or non-conforming loan. That's a dressed-up way of referring to the loan limits and what you can borrow with a conventional loan.
To be a conforming loan, a conventional mortgage has to meet the loan limits spelled out by either Fannie Mae or Freddie Mac. If you've never heard of them, Fannie Mae and Freddie Mac are two government agencies that oversee mortgage lending.
Loan amounts are set by the government, and the maximum conforming loan amount is based on where you live. For most areas, that's $510,400 for 2020. But if you live in certain high-cost housing markets, such as the Washington D.C. area, the limit increases to $765,600 for 2020.
A non-conforming loan wouldn't follow those loan limits or other mortgage guidelines set by Fannie Mae and Freddie Mac. A jumbo loan is an example of a non-conforming loan.
Jumbo home loan basics
A jumbo home loan is a mortgage that exceeds the maximum conforming loan amounts. In other words, it’s a loan that exceeds $510,400 in most areas of the U.S.
Let's go back to the shoes analogy: A conventional mortgage might represent the average size 10, while a jumbo loan is the equivalent of a size 16 shoe.
So, why would someone need a jumbo home loan? The short answer is that a non-conforming loan might be the best fit if you're buying a home with an above-average purchase price or if you live in a more expensive housing market.
Conventional mortgages can only take you so far when buying a home because of the loan limits. Say you're planning to buy a home in 2020, and you need a $600,000 mortgage. Unless you live in a high-cost area, you'd be stuck at the $510,400 conforming loan limit. A jumbo mortgage, on the other hand, could help you borrow the amount you need to buy that home.
Super jumbo loans have the highest loan amounts. Depending on the lender, this kind of jumbo home loan can have loan limits as high as $5 million. Now, that's not typically something first-time homebuyers are looking to spend on a home, but it's worth noting that these kinds of loans exist, in case you decide to make a major home upgrade down the road.
Jumbo vs. conventional loan mortgage rates
One of your biggest concerns with jumbo loans is probably how their interest rates compare with those of conventional loans. Are they high like a Christian Louboutin heel, whereas conventional loan rates are more comfortable, like a loafer?
In terms of mortgage rates, it really depends on which type of loan you're interested in, whether you're looking for a fixed-rate loan or adjustable-rate loan, and how your credit score and financials measure up. The loan term and loan-to-value ratio, meaning how much money you offer as a down payment, also come into play when calculating mortgage rates.
Adjustable rate vs. fixed-rate mortgage
Choosing an adjustable or fixed-rate mortgage can dictate how much you pay for a home loan. Adjustable-rate loans typically have a set interest rate for the first few years. Then, the rate adjusts, based on the benchmark rate it’s tied to. A fixed-rate loan keeps the same rate for the entire loan term.
Think of it like the difference between a pair of trendy shoes and a classic style. An adjustable-rate mortgage might fit you in the early years of owning a home, but if the rate goes up later, it might be a tight squeeze financially. A fixed-rate loan, on the other hand, is something you may be more comfortable with for the long term.
If you've got a great credit score and a larger down payment that puts a dent into the loan-to-value ratio, then it's possible that a jumbo home loan could offer better mortgage rates. The most important thing to consider when comparing rates is how much you'll pay in interest over time.
Remember that mortgage rates can also affect your monthly payments. Running the numbers through a mortgage calculatorcan help you figure out whether a jumbo vs. conventional loan is a better match for your homebuying budget.
Qualifying for a jumbo vs. conventional loan
Aside from comparing loan limits and mortgage rates, there's one more loose end to tie up when weighing jumbo vs. conventional loans: how to qualify.
With both loans, lenders look at the same general things. That includes your credit scores and credit history, income, assets, and debts. For example, a lender will check your debt-to-income ratio to see how much of your monthly income goes to debt repayment.
Where jumbo and conventional loans tend to differ is that jumbo home loan lenders usually set the bar a little higher for borrowers. For instance, you might be able to qualify for a conventional mortgage with a 640 credit score, but you may need a credit score of at least 700 for a jumbo loan.
You'll also need to be able to show you have enough income to make the payments on a jumbo loan. Lenders might also expect you to put 20% or more down on a jumbo mortgage, whereas you might be able to get a conventional home loan with 10% down or even less.
A bigger down payment means more cash out-of-pocket, but there are upsides. For one thing, you wouldn't have to pay private mortgage insurance (PMI). Private mortgage insurance is added on when you put less than 20% down, and it bumps up your monthly payment. If you can avoid it, you’ll save money over the life of the loan.
Just keep in mind that you'll still need to bring cash to the table for closing costs, as well as your down payment. Closing costs cover things like attorney fees, recording fees, and credit check fees that are necessary to finalize your loan. You'll need to budget 2 to 5% of the home's purchase price for closing costs, as a rule of thumb.
So, what's better?
Whether it’s a better fit to buy a home using a jumbo home loan or a conventional mortgage really comes down to how much you need to borrow, how much you're offering as a down payment, and which type of loan you have the best shot at qualifying for.
Some people live in sneakers, while others can’t live without boots. And still others swear by flipflops. To determine what home loan is right for you, you need to try them on for size — and doing the math on down payments, closing costs, and mortgage rates is a good place to start.