Refinancing a Jumbo Loan: How and When to Do It
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Summary:
A jumbo loan is a mortgage that falls outside the standard conforming loan metrics of Fannie Mae and Freddie Mac. Refinancing a jumbo loan will have stricter requirements than a standard conforming loan. But if you qualified for a jumbo loan before, you will probably be able to get a refinance. The decision to refinance is based on several variables, such as debt burden, interest rates, and market timing. But you may be able to get a lower interest rate, a longer or shorter term, or a different interest structure by refinancing. Just remember that you might also have jumbo-sized closing costs.
Middle- and working-class families are not the only ones who need to buy properties with mortgages. Even the wealthy will use mortgages to buy expensive property because of the benefits of using leverage. When you use leverage in real estate, you can increase your ROI substantially by making use of other people’s money — in most cases, a bank. Furthermore, in the United States real estate market, properties that were once considered modest starter homes now cost upwards of $1,000,000.
Whether you are a wealthy investor who wants to make use of leverage or an average Joe looking to buy in an expensive market, you might consider taking out a jumbo loan. And later you might have an opportunity to refinance that loan. Because of the large dollar amounts, the standards are stricter to refinance an existing jumbo loan. You will have to provide more financial documentation of your debt-to-income ratio and cash reserves. If you are considering refinancing a jumbo loan and have the requisite documents, it’s also crucial to understand whether or not you should refinance based on the current economic and housing environment.
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How to refinance a jumbo loan
If you are interested in refinancing a jumbo loan, you will need to follow these steps:
- Call your existing mortgage lender and ask if they offer a jumbo loan refinance.
- If they do not, contact other banks and mortgage lenders to find out if they will.
- Once confirmed, submit relevant documents to the loan officer based on the strict lending requirements.
- Work with the lender until you receive full approval and are happy with the terms and rates.
It’s pretty similar to how you would have gotten your existing mortgage loan, just with different terms and a strict due diligence process. Remember that there may be fees or closing costs involved and it’s not always a good idea. Now let’s look at when refinancing a jumbo loan is (and isn’t) a good idea.
Reasons to refinance (or not) a jumbo loan
Refinancing your jumbo loan could be a great idea, depending on your circumstances and what the economic environment dictates. Here are some pros and cons to consider.
Change the time frame of your loan
If you would like to shorten or extend the time frame of your loan, then a refinance can be a good option. If you extend the length of your loan from 15 years to 30 years, you have more time to pay the loan off and your monthly payments will be lower. That being said, the longer your loan term, the more interest you end up paying.
On the other end, you can shorten your loan term from 20 years to 10 years. Although you will pay a higher monthly payment, you will pay off more principal and less interest with the payments. If you want to pay less interest and be free and clear of any debt on your home sooner, this could be a good option.
Lower interest rates
One of the main reasons for refinancing any type of loan is to take advantage of lower interest rates. This all depends on how the original jumbo loan was structured and if it was at a fixed rate or a floating/adjustable rate. It also depends on mortgage rates in general, as they tend to fluctuate. You might be able to save significantly more money on your monthly payments and interest payments overall if you refinance to obtain a lower rate.
Change interest structure
Changing the interest structure on your loan through refinancing can be a hugely positive benefit if done correctly. This mainly revolves around the original loan structure. Was it a a fixed interest rate or a floating rate, otherwise known as an ARM or adjustable rate mortgage? If you fix your rate, then no matter what happens with interest rates in the future, the interest rate will stay exactly the same.
Borrowers who have an ARM, will see their interest rates change with the interest rate environment, which is based on what the Federal Reserve does. If you have a previously floating ARM and you can fix it to a lower interest rate with a refinance, you could potentially save a lot of money.
Pro Tip
The U.S. retail mortgage industry used to offer a lot more adjustable-rate mortgages, or ARMs. However, after the 2008 financial crisis, many banks and even the federal housing finance agency felt they were too risky. This is why, after 2008, you almost always hear advertisements for fixed-rate rather than adjustable-rate mortgages. That being said, they still exist, and in 2022, demand hit a 14-year high. If you think interest rates are too high and they will decline, you might want to ask your lender about ARM interest rate structures and if they might be a viable option for your plans.
Jumbo cash-out refinance
If you have equity built up in the property and have an existing jumbo loan, you might opt to get some of the cash back by releasing the equity with a cash-out refinance. You take the monetary value of the equity out of your home in cash and then create a new jumbo loan with the lender.
Negatives to consider with a jumbo loan
Although a jumbo loan might make sense for you, there are some drawbacks you should consider. These are:
Closing costs
Not surprisingly, the closing costs for a jumbo loan will always be higher than those of a conforming loan. The closing costs on jumbo loans can be as high as 3-6% versus conforming loans which hover around 2-5%. Plus, 5% is a lot more money on a home that costs $1 million than one that costs $100,000.
Higher interest rates
The amount of interest charged usually correlates to the perceived risk by the lender. Jumbo loans are not guaranteed by the U.S. government through our friends Fannie and Freddie, so the jumbo mortgage refinance rates will be higher than conforming loans.
PMI Insurance
If your equity is hovering around 20% or lower, your lender might require that you take out extra insurance called private mortgage insurance. This additional insurance will increase your monthly mortgage payment. Remember, the lender wants as little risk as possible, and if the equity built up is not quite what they want, they need to mitigate risk by other means.
Jumbo loans 101
Jumbo loans refer to loans that exceed the limits set by the Federal Housing Finance Agency (FHFA), an independent regulator. Because the mortgage amounts are above the government-approved loan limits, jumbo loans don’t come with a Fannie Mae or Freddie Mac guarantee. Therefore, they don’t fall under the “conforming loan” category. This means that the mortgage approval process and underwriting process will be different than for conforming loans.
Based on the limits in 2022, Fannie and Freddie dictate that their conforming loan limits are as follows:
- 1-unit homes: $647,201-$970,799
- 2-unit homes: $828,701-$1,243,049
- 3-unit homes: $1,001,651-$1,502,474
- 4-unit homes: $1,244,851-$1,867,274
One-unit homes are entire residences, such as a villa or a condo, whereas multiunit homes have multiple residences. Hotels and multifamily properties are considered properties consisting of more than one unit. So depending on where you live, your mortgage will most likely be limited from $647,021-$970,799. If you would like to obtain a larger mortgage, your mortgage will not be Fannie-and-Freddie compliant (or nonconforming), and thus you will need to take out a jumbo loan.
Pro Tip
Special statutory provisions establish different loan limits for Alaska, Hawaii, Guam, and the U.S. Virgin Islands. In these areas, the baseline loan limit is $970,800 for one-unit properties in 2022.
Looking to buy a home either with Fannie-and-Freddie backing, or a jumbo loan without? Here are some lenders to consider.
Why do Fannie and Freddie have conforming loans?
Fannie Mae and Freddie Mac are two federally backed mortgage companies that designate loans to be either conforming or nonconforming based on the risk. When you take out a standard mortgage loan that meets Fannie and Freddie’s conditions, then they back that loan up with the power of the U.S. government by buying them and/or guaranteeing them. If the loan falls outside of their conforming loan scope, they don’t guarantee anything. Therefore, the risk falls more on the writer/originator of the loan, such as the bank. Due to this risk, jumbo loans typically require more due diligence by the lender.
Refinancing a jumbo loan
If you received a jumbo loan when you bought a property, you are probably familiar with some elements of the due diligence process. The process of refinancing is relatively similar, and the bank will take a look at the following when you refinance:
Debt-to-income ratio
The debt-to-income ratio is a mathematical representation of your ability to pay your debts versus the income that you receive. It represents the percentage of your income that is used to pay off debts. In most cases, jumbo loans will want a debt-to-income ratio where debt payments do not exceed 45% of your income.
Equity in your home
With a normal loan, you can refinance even if you have negligible built-up equity in your home. With a jumbo loan, lenders prefer that you’ve built up at least 20% equity in your home before you refinance the home.
Cash reserves
The lender will want to take a look at your total liquid assets, such as cash reserves. They will typically want you to have the equivalent of between 6-24 months of monthly mortgage payment. (Keep in mind, with such large mortgage payments, that could easily exceed $50,000.)
In the eyes of the lender, this should cover you if you were to lose your job. Remember, because you have a nonconforming loan, lenders need to be extra careful.
Great credit history
Your credit history should be impeccable if you are going the jumbo loan route. Typically only credit scores solidly in the 700s will suffice. Bankruptcies, foreclosures, and recent bad debt can be detrimental when an underwriter measures your risk profile. Make sure you have all your ducks in a row in regards to your credit before applying.
Full documentation
The documentation you will be asked to provide for a jumbo loan refinance will be over and above what would be required for a conforming loan. If you have a compensation package that consists of bonuses, stock options, and an alternative salary structure, you must provide documentation of all of it to the lender and underwriters.
FAQ
Is it easy to refinance a jumbo loan?
A jumbo mortgage refinance is more difficult than a conforming refinance loan, but still relatively easy. You are required to meet stricter lending requirements and provide more documentation.
Can you refinance from a jumbo to conventional loan?
Yes, you can refinance a jumbo loan into a traditional loan, as long as your mortgage balance is under the limit, which varies from county to county.
Is a jumbo loan worse than conventional?
It’s riskier for the lender and requires more documentation and better finances from the borrower. It’s not worse, per se, just more complicated for the buyer.
What is the interest rate on a jumbo loan?
The interest rate on a jumbo loan may be slightly higher than the interest rate on a conventional loan, but they are pretty similar.
Key takeaways
- Jumbo loans are different than conventional loans as they are outside the scope of Fannie Mae and Freddie Mac’s “conforming” loan limits.
- As the loans are deemed riskier by the lender, they will have stricter lending requirements and require more documentation.
- Jumbo refinance loans can be a good idea if you want to take advantage of lower interest rates, change your interest rate structure, or change your loan terms.
- Jumbo loans will typically have higher closing costs and slightly higher interest rates than conventional conforming loans.
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