What is a Jumbo Loan?

What is a jumbo loan? It is a non-conventional loan that major agencies, such as FHLMC and FNMA, won't buy and trade because of the loan's cost. These two major institutions are very powerful in the mortgage market, and most lenders want to be able to sell mortgage obligations to them to earn liquidity to do more business. Since a jumbo loan fails to qualify for Fannie Mae and Freddie Mac guidelines, borrowers must often pay extra to help lenders countenance the extra risk they encounter for financing it.

Typically, rates for a jumbo loan can be half a percentage point higher than rates for standard conventional loans. Jumbo loans were designed to help high-income individuals afford luxury homes or smaller homes in highly desirable areas. However, thanks to a major inflation in the housing market over the past few years, more and more middle-income Americans have had to turn to jumbo loan financing to get into their dream homes.

Many jumbo loan borrowers end up incurring additional costs during refinancing. Since the size of the loan is usually large (e.g. in excess of Fannie Mae's ceiling of $417,000 for a single-family dwelling), any bump in the interest rate can have major financial implications. An extra point on a mortgage of $500,000, for instance, translates to $5,000 that the borrower must come up with to meet his or her obligation.

That said, lenders are still optimistic about the housing market. They also have ways to protect themselves against long term risk. One of these methods is extending the term of a loan. Many new jumbo loans offer terms of 40 years or even more. By amortizing the debt over a longer period of time, homeowners are able to afford larger places. Lenders, on the other hand, get to reap extra interest rate charges over that period of time.

If you live in certain regions in the country, you may be able to qualify for a conventional loan even if the cost of your mortgage exceeds $417,000. In Guam, the US Virgin Islands, Alaska, and Hawaii, borrowers may cap out at 150 percent of the standard mortgage cap.

However, restrictions to this extended cap do apply, and it's important to know the tax consequences of extending yourself. Also, unless your credit is amazing and you have and you have an established relationship with the lender, you'll likely have to put some money down -- generally 5 percent minimum.