Understanding home loans can feel like learning a new language, especially when you encounter terms such as jumbo loans and conforming loans. But don’t fret. In this in-depth guide, we will break down the key differences between these two primary types of mortgages to help you understand which option is right for you.
Conventional loans: The shared foundation of jumbo loans and conforming loans
Before we dive into the specifics of jumbo and conforming loans, it’s essential to understand their shared foundation: conventional loans. A conventional loan refers to any mortgage that is backed by private mortgage lenders and institutions instead of a government agency (e.g., the Federal Housing Administration).
The majority of the mortgage loan market is made up of conventional loans, which are then further categorized as either conforming or non-conforming. Non-conforming loans are a type of conventional mortgage that falls outside the guidelines of conforming loans. One example is jumbo loans, which go beyond the typical conforming loan limit.
What are conforming loans?
The Federal Housing Finance Agency (FHFA) establishes mortgage guidelines that cover everything from the loan amount to the borrower’s credit score and debt-to-income (DTI) ratio. Any loan that adheres to these guidelines is considered a conforming loan.
The FHFA oversees two critical government-sponsored enterprises (GSEs): Fannie Mae and Freddie Mac. Rather than lending directly to homebuyers, these two industry giants work behind the scenes, acquiring mortgages from private lenders, packaging them into mortgage-backed securities, and selling these investments on the secondary market. This process ensures a steady flow of liquidity for lenders, enabling them to consistently issue new mortgages.
Fannie Mae and Freddie Mac only purchase loans that align with their specific criteria. As a result, lenders are motivated to provide conventional loans that meet these standards. The standardization of these loans reduces risk for lenders, making them the most popular and often the most cost-effective choice for homebuyers.
Key features and requirements of a conforming loan
Consider the following before applying for a conforming loan:
Conforming loan limit
The most defining characteristic of a conforming loan is that its principal balance must be at or below the conforming loan limit established by the FHFA. Conforming loan limits are adjusted every year according to the fluctuations of the national average home price.
The current baseline limit for single-unit properties nationwide stands at $806,500. In some counties, the limit can be significantly higher, reaching up to $1,209,750.
Credit score
Specific requirements will typically vary from lender to lender, but a minimum credit score of 620 is advisable in order to qualify for a conforming loan. Higher credit scores are a plus, as they will typically be granted loans at better interest rates.
Down payment
Conforming loans are known for their flexible down payment options. You can get a conforming mortgage with as low as a 3% down payment. If your down payment is 19% or lower, you’ll need to pay for private mortgage insurance (PMI), which safeguards the lender if you are unable to pay the loan. The silver lining? Once you’ve built 20% equity in your home, you can cancel PMI, saving you money in the long run.
DTI ratio
Lenders assess your financial capacity using your DTI ratio, which represents the percentage of your monthly income dedicated to debt repayment. While a DTI of 43% is a common benchmark, many lenders will accept a higher ratio depending on other factors in your application, such as your credit score and cash reserves.
Jumbo loans explained
So, what happens if the home of your dreams is in a high-cost area or simply has a price tag that exceeds the conventional loan limits? That’s where a jumbo loan comes into play.
Jumbo mortgages are conventional loans that are classified as non-conforming, as they typically go over the FHFA’s established loan limits. These loans cannot be purchased by GSEs, and they present a greater risk for lenders. As a result, jumbo loan requirements are significantly more rigorous than those for a conforming loan.
Jumbo loans are an ideal choice for financing high-end homes or properties in premium real estate markets. However, they are a double-edged sword: they tend to have some flexibility from lender to lender, but their qualifications are much stricter to mitigate the increased risk.
Key features and requirements of a jumbo loan
Obtaining a jumbo loan involves meeting specific requirements and understanding essential features:
Loan amount
For a jumbo loan, you need to borrow an amount that exceeds the maximum loan limits of a conforming loan. For example, if the limit in your county is $806,500 and you need to borrow $1,000,000 to buy a home, you’ll need to apply for a jumbo conventional loan.
Higher credit score
You need an excellent credit score, usually 700 or higher, to qualify for jumbo loans. Lenders seek confidence that you’re a reliable borrower with a solid history of managing debt responsibly.
Larger down payment
Jumbo loan issuers will typically require a large down payment, in the region of 10–20% or more. The specifics of the loan program and the borrower’s financial situation will both be factored into the final down payment rate. This higher down payment minimizes the lender’s risk while creating a stronger loan-to-value ratio buffer.
Substantial cash reserves
You need to guarantee lenders that you can handle the large monthly payments and any unexpected financial challenges. Often, this means showing proof that you have enough liquid assets (e.g., cash, cash equivalents, and other assets that are easily convertible to cash) to cover your mortgage payments for a significant period (often 6–12 months) after the purchase.
DTI ratio
Jumbo loans typically require a lower DTI ratio than conforming conventional loans. Your jumbo loan request may be approved if the monthly payment is equivalent to 43% or less of your monthly income. However, approvals are on a case-by-case basis.
Interest rates
As jumbo loans involve larger sums of money, they historically posed a greater risk to the lender than conforming loans. However, increased competition among lenders has significantly narrowed this gap. In many cases, jumbo mortgage rates are now on par with or even lower than conventional loan interest rates, especially for borrowers with impeccable credit and strong finances.
Jumbo loan vs. conforming loan: How to choose which loan is best for you
Deciding between jumbo loans and conventional loans largely depends on the amount of financing you need:
- If the price of your dream home falls within your area’s conforming loan limit, a conforming mortgage is the better choice for you. A conventional conforming loan is the go-to option for many homebuyers, particularly those in lower- to middle-income brackets. Apart from being widely available from any lending institution, a conforming mortgage’s standardized process, flexible down payment options, and more relaxed qualification criteria make it an accessible and affordable financing solution.
- If the home you’re looking for requires a loan amount that exceeds the conforming loan limit, a jumbo mortgage is your necessary path to homeownership.
Directions Home Loan can help you further understand the difference between jumbo loans and conforming loans, so you can determine which mortgage is best for you. We also provide assistance on applying for other conventional loans.
Whether you’re buying a starter home or a luxury estate, we provide personalized support and competitive rates with fixed or adjustable options to meet your needs. Start your homeownership journey today — contact Directions Home Loan now!
