Why Do Jumbo Loans Have Lower Rates?

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Why would a bank give a lower loan rate to someone who wants to buy an expensive home? If they can afford a higher-priced home, can’t they afford a higher loan rate? Why help the rich get richer?

Despite what you may think, jumbo loans do not translate into jumbo-sized rates. Getting a big loan for a more expensive house has more financial upsides than you think.

A Quick Overview of Jumbo Loans

Jumbo loans are also referred to as non-conforming loans and are mortgage transactions that require lending money above Fannie Mae and Freddie Mac conforming loan lending limits.

In 2024, those amounts vary by where you live and can top out at for one-unit properties at $766,550, an increase of $40,350 from 2023. If you live in an area where real estate prices are designated as higher cost, the ceiling loan limit for one-unit properties is $1,149,825, which is 150% of $766,550. Amounts are adjusted annually.

Special statutory provisions establish different loan limits for Alaska, Hawaii, Guam, and the U.S. Virgin Islands. The baseline loan limits in these areas are $1,149,825 for one-unit properties.

To qualify for higher loans, jumbo loan borrowers must often have lower debt-to-income ratios, higher credit scores of 700 or better, larger down payments of at least 20%, and higher reserve funds than conforming loan borrowers.

Jumbo loans also have stricter loan-to-value (LTV) ratio requirements. Your LTV measures how much money the property is worth vs. the loan amount.

It is calculated by dividing your total mortgage amount by the appraised value or purchase price of the property, whichever is lower. Jumbo loans may require you to have an LTV of 80%. Some lenders may require an even lower LTV.

This removes much of the risk associated with defaults, translating into lower interest rates for borrowers. Because jumbo loans require down payments of at least 20%, borrowers are more protective of not defaulting, meaning a jumbo loan home is better collateral for the bank.

The government uses Fannie Mae and Freddie Mac to purchase conforming mortgages, making regular mortgages less risky for lenders.

However, jumbo loans aren’t sold to Fannie Mae or Freddie Mac, so banks have more flexibility with down payment and debt-to-income ratios. Also, Fannie Mae and Freddie Mac charge “guarantee fees” to help guard against defaulted loan exposure. Jumbo loans are also cheaper, in part because they don’t have such fees.

Because there is less perceived risk for jumbo loans, lenders are extremely competitive with terms and conditions to attract more wealthy and conservative buyers.

Other Benefits for Lenders

By making jumbo loans appealing to high-wealth customers, banks can use the loans to cross-sell auto loans, credit cards, home improvement loans, lines of credit, checking accounts, and other bank services, often creating a client-for-life relationship.

For example, some lenders give a 0.25 percentage point jumbo loan discount to borrowers who open a checking or savings account and sign up for automatic mortgage payment.

Banks can also offer lower rates on jumbo loans because they offer low yields on customers’ deposits, usually below 1% on savings accounts. That means they can lower the APR for jumbo loans and still profit from the difference.

Why Investors Seek Jumbo Mortgages

Another reason jumbo loans are cheap is because investors want them, and there isn’t much supply. Historically, the spread between conventional conforming and non-conforming jumbo loans is 0.50 to 1 percentage point.

However, markets are in a constant state of flux, and to get deals like this, you may have to time your purchase and competitively shop for the best deal based on your needs.

Almost all mortgage loans are packaged into pools and sold to investors. The investors replenish their cash by raising money, usually by issuing debt in the form of bonds, secured by the cash flow from the mortgages in the pool.

Again, a safer pool of jumbo mortgages is seen as more attractive for pool buyers, increasing the ability of mortgage loan pools to be more liquid.

Jumbo Loan Closing Costs

Jumbo loan mortgages have higher closing costs than normal mortgages because qualifying is more stringent, and the higher qualifications take additional time and due diligence.

You may also need to pay for a second home appraisal once you settle on a lender to offset some of the lender’s risk. Review all fees before moving forward with a jumbo loan so you can decide if a jumbo loan is the best option for you or if you should consider other financing alternatives.

Kara Johnson

Kara is a Rye, New York-based author and contributing writer for Refi.com. She is a graduate of Hampshire College.

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