If you’re looking to make a sizable property purchase for either personal housing or a real estate investment, you may be looking into a jumbo loan to help with financing. Since jumbo loans are typically for property purchases of half a million dollars or more, they are particularly desirable for those who have recently begun high-earning careers.
Of course, with big reward also comes big risk. As an unfortunate result, you should be aware of some unavoidable disadvantages of jumbo loans before pursuing them.
What are the Disadvantages of a Jumbo Loan?
While all loans have some disadvantages, certain ones are uniquely applicable to jumbo loans.
Four disadvantages of jumbo loans are:
- More demanding requirements for approval
- Higher interest rates
- Increased closing costs
- Tied-up liquid assets
Most of the disadvantages are tied together, which is what makes them unavoidable. Keep reading, as we explain these disadvantages in more detail.
Additional and Demanding Requirements
Jumbo loans are even more difficult to get approved than regular loans for a variety of reasons. The first half of why it is more difficult is the more stringent requirements that you must pass. Besides being able to pass the basic FHFA regulations for loan approval, you also must pass additional requirements like:
- Credit score of 700 or above
- Low debt-to-income (DTI) ratio
- Upfront cash for down-payment
- Substantial liquid assets
- At least six months worth of mortgage payments in cash
- Proper documentation of all loans and hard assets
In addition to these “basic” requirements, many lenders have their own set of requirements. This is the second half to why jumbo loans are so difficult to get.
Your options for lenders are more limited because most financial institutions are not willing to risk jumbo loans. In addition, jumbo loans cannot be purchased, guaranteed, or securitized by federally backed secondary mortgage companies like Fannie Mae and Freddie Mac.
You should be aware of some more strings attached when you borrow from jumbo loan lenders.
Expect Higher Interest Rates
Due to increased risk, jumbo loans are more likely to have higher interest rates. While that is not always the case, there are a few things that contribute to its likelihood.
Factors that influence jumbo loan interest rates are:
- Fixed-rate vs. adjustable-rate mortgage
- Debt-to-income (DTI) ratio
- Credit score + history
- Amount of cash and assets
Fixed-rate mortgages tend to be more expensive than adjustable-rate; additionally, they are approximately a 30-year commitment. While your DTI and credit score may be good enough to get you approved, they may not be enough to get you a good interest rate. Also, if you have a good credit score but a nearly non-existent loan history, you are seen as riskier, which makes you more susceptible to higher interest rates.
There are also factors outside of the applicant’s control, like stability and competitiveness of the market. The more options you have for lenders, the better rates you’re going to find.
Closing Costs are More Expensive
Because jumbo loans are so risky, lenders want to ensure they are not lending more money than necessary and reduce risk as much as possible. Unfortunately, this considerably raises the closing costs (i.e., fees paid at the end of a real estate deal besides the property’s price).
Closing costs can consist of fees from:
- Real estate attorney
- Mortgage loan application
- Various insurances
- Property and transference taxes
- Homeowners’ association (HOA)
- Title and record filings
Typically, lenders require a property to be inspected multiple times and have the value appraised at least twice, so that is another significant cost that needs to be considered. There is still another disadvantage of taking out a jumbo loan to be considered.
Your Liquid Assets will be Tied Up Afterwards
Undeniably, if you are approved for a jumbo loan and proceed to purchase property, you will end up with less liquid assets than you started with.
A significant amount of cash or liquid assets must be given upfront for:
- Down payment
- Escrow deposit
- Six-months-worth of mortgage payments
This means if you need cash in a pinch, you’ll be out-of-luck for the foreseeable future, which is a significant personal risk.
As further salt in the wound, if you want to get out of your jumbo mortgage, you’ll have to put up another lump of cash to get it low enough to be sold to a secondary mortgage loan company. This will be difficult to accomplish if all your liquid assets are tied up in the loan already.
In conclusion, while jumbo loans can help finance grand aspirations, they bear significant risks all-around.
Even if you make a decent amount of income, have a good credit score, and have a low DTI, you may struggle to find a willing lender and get approved. If you do get approved, you will have to deal with higher interest rates and closing costs. In addition, you’ll ultimately have fewer liquid assets.
These disadvantages may make you think twice before seeking a jumbo loan.