Jumbo loans pose a higher risk to lenders. You borrow more money, which naturally makes you a higher risk. It doesn’t matter if you have great credit and low debt ratios, just the amount of your mortgage puts the lender at risk for default.
Does this risk automatically give you a higher interest rate though? It really depends on each situation. Below we help you understand what lenders consider before giving you an interest rate on your jumbo loan.
The Demand in the Market
Most lenders sell their loans, with the exception of portfolio lenders. If you are a standard borrower with good credit and decent debt ratios, you won’t need portfolio lenders. If you use a lender that sells mortgages, your interest rate will depend on the demand. Are there investors out there waiting to buy your loan? Are there a lot of investors competing for the loans? If so, you have a better chance of securing a lower interest rate because investors want your business.
If the demand in the market is low, meaning that there aren’t a lot of investors vying for your loan, the rates may be higher. Lenders need to make your loan enticing for investors to want it, which means they need to be able to make more money on it. If the demand is down, you’ll likely pay the higher interest rate.
Your Individual Factors
Now, the demand in the market doesn’t matter if you don’t have the good qualifying factors to back it up. Just like a conforming loan amount, lenders need to look at your individual risk of default. The riskier your loan profile, the higher the interest rate a lender will charge. You can expect the rate to get even higher if you need a jumbo loan amount.
Consider the following factors before applying for a jumbo loan:
- Maximize your credit score – It’s a good idea to start working on your credit score at least 12 months before you apply for a jumbo loan. Typically, jumbo loans require a higher credit score for you to qualify for it. But, the higher your credit score is, the lower the interest rate a lender can provide. Lenders base your interest rate on your risk of default and a high credit score can help decrease that risk.
- Lower your debt ratio – Another factor in your risk of default is your debt ratio. Your jumbo mortgage payment will likely take up a good portion of your income. If you have other outstanding debts on top of it, you put your risk of default higher than it would be if you didn’t have other debts. If you have the chance to pay off other debts or at least pay them down, you lower your risk of default, which may give you a lower interest rate.
- Choose the right loan type – Lenders base your risk of default on the type of loan you take too. If you choose an ARM loan, for example, you are a higher risk of default because your interest rate has the chance to increase over the life of the loan. The same is true for your loan term. If you choose the maximum loan term of 30 years, you put the lender at the greatest risk of default. If you borrow their money for less time, say 15 or 20 years, you lower that risk and therefore lower your interest rate.
- Increase your down payment – Another way to lower your interest rate is to increase your down payment or decrease your loan-to-value ratio. The lower your LTV, the less risk the lender faces of default. When you have your own money invested in the home, you are more likely to make your payments or you put your own money at risk.
Other Ways to Get a Lower Interest Rate
You have one more way to get the lower interest rate that you want. You can buy it down with what they call ‘discount points.’ This is a fee you pay at the closing in the form of a percentage of your loan amount. Most lenders will discount your interest rate 1/8th to 1/4th for every point that you pay. For example, on a $500,000 loan, one point would equal $5,000.
Of course, this only makes sense to do if you will stay in the home for the long-term. If you know, you’ll move in the next five years or so, it doesn’t make sense to pay more money upfront. Lenders consider this money prepaid interest. They give you a lower interest rate over the life of the loan if you agree to pay it upfront.
Getting the lowest interest rate on your jumbo loan is in your hands. The more work you do ahead of time to decrease your risk of default, the better interest rate you will get. Of course, you should also shop around to find the lender that will give you the best rate on your loan.