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When it comes to buying luxury real estate, cash may no longer be king. Dropping cash on a multimillion-dollar home means tying up your liquid funds. And with mortgage rates at historical lows, that money is probably best invested elsewhere, so financing might be the smarter option.
Buying a mansion with a jumbo mortgage is a bit different than financing a modestly priced property using a traditional fixed-rate loan. A jumbo mortgage comes with its own set of special rules, which we will walk you through to help secure purchasing that mansion.
What Is a Jumbo Mortgage?
Most conventional mortgage loans are known as “conforming loans,” named so because they conform to lending standards set by the Federal Housing Finance Agency (FHFA), which oversees Fannie Mae and Freddie Mac loans. With conforming loans, lenders are protected against losses if a borrower defaults.
Each year, the FHFA sets the maximum amount for conforming loans on single-family homes. In 2021, that cap is $548,250 for most parts of the country. However, in certain areas with a higher cost of living (such as parts of California, Hawaii and Washington, D.C.) conforming mortgage limits are allowed to be 150 percent higher (for a max of $822,375).
Mortgages that exceed these maximums are known as “non-conforming conventional mortgages,” commonly referred to as jumbo loans. These loans are not guaranteed by the government, and therefore, are riskier for lenders depending on the borrower’s creditworthiness. As such, the underwriting standards are more strict than conventional loans.
Jumbo Mortgage Requirements
Since jumbo mortgages aren’t under the purview of the FHFA, lenders can set their own criteria for approval. That often means these loans can be harder to get.
First, you need good credit to qualify for a jumbo mortgage. Lenders typically require a score of at least 700 to borrow up to $1 million. For even larger loans, you may need a score in the range of 720-760.
To ensure that your credit is in good shape, you can pull a copy of your credit reports from each of the three major bureaus (Experian, Equifax and TransUnion) through AnnualCreditReport.com. Make sure you review your reports for any errors or negative items that need to be addressed before applying for a loan.
Lenders also will examine your debt-to-income ratio (DTI). This is a measure of how much of your monthly gross income goes toward paying off debt, expressed as a percentage. For example, if your income is $15,000 per month and you have credit card, student loan and car payments totaling $4,500 per month, your DTI would be 30 percent.
Most mortgage lenders require your DTI ratio to be less than 43 percent when calculating all your debt against your monthly income, including your mortgage payment.
Interest rates are exceptionally low right now, and jumbo loans are no exception. While the increased risk associated with a jumbo mortgage historically meant higher interest rates, that’s not the case today. The average 30-year jumbo mortgage rate was just above 3 percent in early July, or roughly the same cost of a conforming loan.
Adjustable rates for jumbo mortgages are a bit higher. For example, the average annual percentage rate (APR) on a 5/1 adjustable-rate mortgage (ARM)—meaning, the interest rate is fixed the first five years and then becomes an adjustable rate for the remainder of the loan life—ran above 3.7 percent in June. Closing costs may also be more expensive since there’s a greater administrative burden involved in underwriting a jumbo loan.
Lenders typically will require a substantial down payment of 20 percent or more for a jumbo mortgage. That means coming up with $200,000 in cash as a down payment for a $1 million house. Some lenders may accept as little as 10 percent down, depending on the situation.
Jumbo Loan Alternatives
It’s definitely possible to finance a mansion with a jumbo loan. The real question is whether you should.
When weighing the pros and cons of a jumbo loan, you’ll want to keep cash flow in mind. A $1 million mortgage with a 15-year term and 3 percent interest rate would mean you’re on the hook for more than $5,700 per month. If your income is unpredictable and you don’t have a ton of cash reserves, you could find yourself shuffling finances around to come up with the payments.
You might decide that you’re better off using another financing option. For example, depending on the property’s price, you may be able to use a piggyback loan instead. This allows you to take out two smaller mortgages instead of one jumbo loan.
A common piggyback loan structure is 80/10/10. This means you take out one mortgage for 80 percent of the amount you want to finance, then you borrow another 10 percent using a second loan and you provide a down payment for the remaining 10 percent. This also helps you avoid paying private mortgage insurance, which lenders may require to insure against you defaulting on a loan.
Keep in mind that you’ll still have to fit payments into your monthly cash flow and keep track of two loans instead of one.
Another option is to come up with a much larger down payment, such as 50 percent or more. This can help you borrow less and stay within conforming loan limits, resulting in lower rates and fees as well as smaller monthly payments. Again, you’ll have to determine whether you’re better off using your cash for a down payment, using it to pay off high-interest debt or invest it while you save up more.
When it comes to purchasing luxury real estate, you have plenty of options. The key is crunching the numbers by figuring out how to best put your cash to use and how you can leverage low-interest-rate debt to your advantage.
Casey Bond is a seasoned personal finance writer and editor. In addition to publishing in Forbes, her work has appeared on HuffPost, Business Insider, Yahoo! Finance, MSN, The Motley Fool, U.S. News & World Report, TheStreet and more. Follow her on Twitter @CaseyLynnBond.