3 Pitfalls of Taking Out a Jumbo Loan

Taking out a larger mortgage? Beware these drawbacks.

Most people who buy a home need a mortgage to pay it off over time. But what if you're buying a more expensive property? If that's the case, you may need to apply for a jumbo mortgage.

A jumbo mortgage doesn't just mean a large mortgage. There are specific borrowing limits that dictate whether your mortgage falls into the conforming loan category or jumbo category.

Those limits change every year, but in 2021, the conforming loan limit for a single-family home is $548,250. That said, in some parts of the country, the limit is $822,375. Those areas include Hawaii and Alaska, where property prices tend to be higher.

A jumbo loan could be your ticket to the property of your dreams. But be aware of these drawbacks.

1. You'll generally get stuck with a higher interest rate

There's a reason borrowers with high credit scores are rewarded with competitive mortgage rates. Because there's less risk to lenders, borrowers get to reap some savings.

Jumbo mortgages are, however, more risky than conforming loans by nature, since they involve larger sums of money. As such, jumbo lenders expect to be rewarded for taking on that risk via higher interest rates.

As of this writing, the average interest rate for a 30-year fixed mortgage is 3.164%. Jumbo mortgage rates, on the other hand, are 3.23%.

That may seem like a small difference. But if you were to borrow $700,000 at 3.16%, your monthly payments would be $3,015 for principal and interest, and you'd spend a total of $385,411 on interest in the course of paying off your home. At 3.23%, your monthly payment goes up to $3,038, and your total interest increases to $393,679.

Of course, you can argue that an extra $8,268 in interest over 30 years is worth it for getting to borrow more. But that assumes a modest difference in interest rate. Depending on where you live and what your credit score looks like, the difference between a conforming loan and a jumbo loan may be greater from an interest rate perspective.

2. You'll have to make a larger down payment

When you take out a conventional mortgage, you can sometimes get away with making less than a 20% down payment. Not with a jumbo loan, though. Jumbo lenders will almost always want a 20% down payment at a minimum, which means you'll not only have to save more money ahead of buying your home, but also, tie up more cash in that home from the start.

3. You could face higher closing costs

When you take out a mortgage, you pay a series of fees to finalize that loan known as closing costs. Closing costs are generally calculated as a percentage of your loan amount, so the more you borrow, the more you'll pay.

But some jumbo lenders may also impose higher fees because, frankly, they can. There's a more limited market for jumbo loans than conventional loans, so mortgage lenders don't have to work as hard to be competitive. As such, a jumbo lender might stick you with a higher application fee than you'd pay for a conforming loan, which could, in turn, drive up your total closing costs.

A jumbo mortgage may be necessary if you're buying a more expensive home, and it's not necessarily something to worry about or be afraid of if you can afford it. Just be aware of these pitfalls before you apply.