Jumbo vs. Conforming/Home Equity
Choosing the Best Option for Large Mortgages
The spotlight has been on the subprime mortgage market for over six months now. Unfortunately all this attention on mortgages has made the jumbo mortgage market an additional casualty of war. In the midst of all of the turmoil, buyers must now decide between pursuing a jumbo loan or attempting to secure a conforming loan with an additional home equity loan attached. Here are a few plus and minuses, plus some definitions for those readers that may be thoroughly confused.
The Jumbo Loan Market
The jumbo loan market represents loans that are above $417,000. Currently the median home price in the US hovers around $225,000, so many homebuyers will not have to concern themselves with jumbo loans. Buyers in California, New York, Florida, and other major markets will encounter these loans for many properties they intend to purchase, however.
Normally, jumbo loans have slightly higher interest rates because they are not guaranteed by the US Federal Government, like conforming loans. Additionally, they are bigger. That simple fact makes them riskier than their smaller counterpart, the conforming loan.
Recently, jumbo loan interest rates shot up dramatically, introducing the possibility of securing a conforming loan with an additional home equity loan filling out the remainder. Jumbo loan rates increased for several reasons, many connected with the subprime loan market fallout. It all boiled down to perceived risk. Banks and many investors believe that the risk of real estate prices declining is high. Defaults tend to increase as real estate prices decrease, making loaning in this kind of market a riskier than normal proposition. This basic theory lead banks to drastically increase interest rates on jumbo loans.
Jumbo Mortgage vs. Conforming Mortgage with Home Equity Second
Traditionally, jumbo mortgages have been significantly cheaper than the combination of conforming mortgages and home equity loans. This is because home equity loans have an interest rate that is about 1.5% to 2% higher than jumbo loans, and that difference was not made up by the lower interest on the conforming portion of the loan. As jumbo rates have risen; however, this relationship is being reevaluated. While the actual difference will depend on the borrower’s credit score and their specific situation, the gap is narrowing significantly.
Consumers need to be aware that while jumbo mortgages will certainly have lower closing costs, the conforming/home equity loan has a very unique payoff feature. Since the home equity loan is a separate loan, it can be paid off early. This lowers a borrower’s payment and could dramatically lower their interest rate as well. While prepayments will reduce the total principal on the jumbo, the required monthly payments will remain the same. By having the option to prepay the home equity loan, a borrower can reduce their principal and lower their interest payments at the same time. This strategy would essentially be equivalent to refinancing a jumbo mortgage.
When choosing between these two options a borrower should think about their future cash flow and their future home plans. Buyers planning to stay in their home for a long period of time should probably opt for the conforming/home equity now because they are not much more expensive and could lead to much lower payments in the future. Borrowers looking to move in less than five years should stick with the jumbo mortgage because of its lower upfront cost and lower monthly payments.
