Which loan is best for you? A jumbo or conventional mortgage

Do know what a jumbo loan is

Any loan above the $417,000 is considered a jumbo loan. Loans $417,000 or below are considered conforming loans and fall under conventional guidelines set by Fannie Mae and Freddie Mac. Every year, the government decides if the conforming loan limit needs to be changed. We have been at $417,000 for some time.

Do know the difference between a jumbo loan and a conventional loan

The main difference is that there is a huge market for conventional loans and they are able to be sold and secured on the secondary market. This is done mostly through the help of Fannie Mae and Freddie Mac, who are government entities who will insure these loans if they are underwriting to their guidelines. This helps lenders in two ways. First it frees up capital by allowing the lender to sell the mortgage and get that money back so they can lend again. Second, the lender is comfortable in knowing that if these loans are underwritten to conventional guidelines, they will be protected in case the loan goes into default.

Do find out which loan is better

Due to the fact that there are many more conventional loans than jumbo loans, the rates are lower and the cost to get a conventional loan are less expensive. Also, the guidelines to qualify for a conventional loan are easier. But each loan serves a purpose. If you are looking to buy an expensive property, your only option is the jumbo loan.

Do figure out if you have to pay mortgage insurance

In the past, if you did not put 20% down, you could not get a loan. Then insurance companies developed a new product called private mortgage insurance (PMI). This PMI allows borrowers to purchase insurance on behalf of the lender, which protects the lender in case the borrower goes into default on their loan. Since lenders are protected, they are willing to lend to higher loan to value ratios. If a borrower puts 20% down, they are getting a loan with a loan to value ratio of 80%. With PMI, the borrower can get a loan with as little as 3% down or a 97% loan to value ratio.

Do know there is no PMI for jumbo loans

PMI is great for conventional loans, but there is no PMI product for the jumbo loan market. So in most cases, you will need to put a minimum of 20% down depending on purchase price when getting a loan.

Do not forget about a piggyback loan

What is a piggyback loan? It is a loan structure when you combine a first and second mortgage together. The purpose is to achieve a higher loan to value without the need of mortgage insurance. This is especially helpful in the jumbo market. So if you are buying a home for $550,000, you would normally need to put 20% down or $110,000. Some borrowers might want to put less money down and apply for a second mortgage for 10% to 15% of the purchase price or $55,000 to $82,500. This allows them to bring just 5% to 10% down payment plus closing costs to closing.

Do not dismiss your second mortgage options

It really depends on the terms of the 2nd mortgage. In most cases, you will get better terms and rate with a first mortgage. Main reason is that the first mortgage is in the first lien position. If the loan goes bad, the first mortgage company is protected and the second mortgage is wiped out. So the second mortgage will charge more for the risk. There are two types of 2nd mortgages: a fixed and a variable. The nice thing about a fixed is that the rate is fixed and you know what your payment is, but these rates are usually much higher than the first mortgage payment. The variable rate or HELOC is usually an interest only loan that is variable based on an index. In most cases, the HELOC is tied to the prime interest rate, which is currently 3.25%. So with a HELOC, you are sharing the interest rate risk with the bank. So if the rate goes up, the bank is insured to get the same rate of return on their money, but while interest rates are low, it is great for the borrower.

Do not forget about the pros and cons of a piggyback

The pros of a piggyback mortgage option is you can borrow more money and conserve cash. They work great for smaller loan amounts. The cons of the piggyback option is that the rates on the second mortgage might be higher. The first mortgage company may have a price adjustment for adding a second mortgage and lastly, if you choose the HELOC, this rate is variable and with larger loans, the payment can increase a lot when rates start to go back up to historic levels. In all cases, the best thing to do when considering what loan is best is to talk with a mortgage professional and have him run a few scenarios for you. Each scenario has its pros and cons and by getting the facts, it will make your decision much clearer.