Since early 2000s, real estate prices have been on the rise. For example, in San Francisco, the median home price for a two-bedroom home has increased over 228%. To put this in perspective, in the year 2000 one could have bought a two-bedroom home for $420,000; that same home would now cost $1.38 million[1]. This rapid increase in price has pushed people out of the conventional or “conforming” loan market and into jumbo loan territory.

There are two types of mortgage loans: conforming and non-conforming. A conforming loan is a mortgage that falls within the Government-Sponsored Enterprise (“GSE”) guidelines. The agency Federal Home Loan Mortgage Corporation (“Freddie Mac”) or the Federal National Mortgage Association (“Fannie Mae”) are two examples of GSEs. These entities were created to help support the mortgage loan market by guaranteeing third-party loans and buying mortgages on the secondary market to help provide liquidity to financial institutions. To control the GSE’s risk, the agency places a maximum amount they will guarantee or buy as it relates to the dollar amount of a mortgage. There are two different limit guidelines, which include a baseline limit of $484,350 and a high-cost area maximum limit of $726,525, or 150% of the baseline limit[2] for 2019. Said differently, if one were to buy a home in a baseline limit area and their total mortgage was below $484,350, then they would be acquiring a conforming mortgage, meaning it would be guaranteed or backed by one of the GSEs. If their mortgage were above the limit, they would need to take on a non-conforming or jumbo mortgage loan.

A jumbo loan mortgage sits outside of the GSE’s guidelines, which prevents GSEs from backing or buying these mortgage amounts in the secondary market. Because GSEs cannot back this type of loan it creates more risk to the financial institution, forcing them to require different underwriting criteria. For example, when applying for a conforming loan one may be able to only put 3% down on their mortgage. If the same individual were to apply for a Jumbo loan the bank will typically require a minimum of 10% and often at least 20% or even 30% down. Credit scores typically must be at 700 or above and a debt-to-income[3] ratio of no more than 45%. Financial institutions will also require jumbo loan applicants to have a significant amount of cash on hand. For example, lenders may require a jumbo loan applicant to provide proof of 6-12 months’ worth of mortgage payments in reserves. If an individual were seeking to get an $800,000 mortgage at 4.5% interest rate on a 30-year amortization schedule, that person would have to show anywhere from $24,321 to $48,642[4] of cash reserves. Lastly, the financial institution will also want to see an income stream that can support the higher mortgage cost.

Underwriting jumbo loan mortgages well are one way for financial institutions to mitigate their risk, but they can also lower their risk by requiring jumbo loans to use different terms. When it comes to conforming loans, fixed terms such as 30-year fixed or 15-year fixed are common. However, when institutions are lending jumbo loans, they may not allow the applicant to lock in a 30-year fixed mortgage. They may instead only offer a 7/1 adjustable-rate mortgage (ARM) on a 30-year amortization schedule. This helps financial institutions force lenders to decrease the interest rate risk they take on with such large loans. Financial institutions don’t want to lend out close to $1,000,000 at 4% when, in five years, rates could be closer to 5-6%, causing the bank to lose out on potential interest earned. Also, if inflation were to go about the 4% mark, the institution would lose money on the aforementioned loan. Historically, jumbo loans were also more expensive than conforming loans as they were riskier, and the institution would need to be compensated for such risk. The financial institution mitigates these risks by pushing an ARM instead of a fixed-rate mortgage. When looking at rates today, a 30-year fixed mortgage would be 3.76% vs. a jumbo loan fixed mortgage of 4.21%[5].

When seeking to buy a higher-priced home it is important to know if the mortgage will breach the GSE guidelines. If one were sitting in the jumbo loan arena, it is important to factor in the difference in underwriting and how the bank will position the term of the loan. If a couple has the ability to lock in a fixed rate with a modest down payment, that could be more attractive than accepting an ARM with an overall lower monthly payment. At LBW, we are happy to walk you through the process and help you grasp the impact of such a large purchase on your overall financial health. We do not believe that one recommendation fits all, and we do our best to provide you with direction and positioning to achieve your short, medium, and long-term goals.



[1] https://www.businessinsider.com/san-francisco-housing-market-facts-rent-2019-5#the-median-sales-price-for-a-two-bedroom-home-in-san-francisco-has-increased-329-since-2000-5 – edited percentage number for accuracy.

[2] https://www.fhfa.gov/mobile/Pages/public-affairs-detail.aspx?PageName=FHFA-Announces-Maximum-Conforming-Loan-Limits-for-2019.aspx#targetText=%E2%80%93%20The%20Federal%20Housing%20Finance%20Agency,increase%20from%20%24453%2C100%20in%202018.

[3] https://www.investopedia.com/terms/d/dti.asp

[4] LBW Wealth Management

[5] https://www.wsj.com/market-data/bonds?mod=md_home_overview_bonds_main

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