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Jumbo mortgages are used to obtain loans that exceed the federal lending limits, and they are often needed to purchase expensive properties or homes in desirable areas. Unlike traditional mortgages, jumbo loans are not eligible for purchase by Fannie Mae or Freddie Mac, which makes them a riskier investment for lenders. That means they come with stricter requirements and higher interest rates. For homebuyers, having cash reserves on hand is crucial to obtaining a jumbo home loan. Having lots of cash at your disposal after closing will show lenders that you have stable finances and will be able to cover your payments in the future.Let’s look at why cash reserves are so important for this process.
Understanding jumbo mortgages
Jumbo mortgages are loans that exceed federal lending limits set by the Federal Housing Finance Agency. These are considered a higher risk for lenders and come with more stringent requirements: higher credit scores, larger down payments, high interest rates, and large reserves of cash on hand.
Jumbo loans are common in popular and high-cost housing areas, such as New York City or San Francisco. Those are areas where home prices may exceed the lending limits set for traditional loans. The jumbo loan market helps keep property values high by allowing the acquisition of luxury homes and expensive investment properties. Buyers and investors with the means can often meet the strict requirements for the loan and will support the growth of that area’s high-end real estate market.
Importance of cash reserves
Cash reserves can make a lender feel much more confident about issuing a jumbo loan, as reserves help indicate financial stability and a low-risk investment. It means you have lots of liquid assets on hand that can be used to pay for the loan. These can include savings accounts, checking accounts, and other funds that can be easily accessed in case of unexpected expenses or income disruptions.
Cash reserve requirements are higher than those for traditional loans that conform to the federal lending limits. Lenders might require up to 12 months of mortgage payments be set aside in reserve to ensure you can pay the mortgage, though this can vary based on your financial profile and loan size. Some lenders ask for even stricter requirements for borrowers who are less financially stable.
Let’s look at an example to help illustrate. A couple wants to buy a home in San Francisco for $2.5 million. To afford it, they need to take out a jumbo mortgage since the amount exceeds the federal lending limits.
Home Price: $2,500,000
Down Payment: 20% (a common requirement for jumbo loans)
Loan Amount: $2,500,000 – ($2,500,000 × 20%) = $2,000,000
Interest Rate: 4% (annual rate for jumbo loans)
Loan Term: 30 years (360 months)
Let’s say the monthly payment is $6,000. Then, you can figure out the required cash reserve: Required Cash Reserves: 12 × 6,000 = $72,000.
So, you would need $72,000 in cash reserves to qualify for a jumbo loan.
Factors influencing cash reserve requirements
Several factors influence cash reserve requirements and can vary loan by loan:
Loan size and LTV ratio
The larger the loan, the more cash reserves are usually required. The same goes for the higher loan-to-value, or LTV, ratio. A high LTV typically means a buyer has less equity, which can mean a higher risk for lenders.
Credit score and debt-to-income ratio:
Lenders want to see creditworthiness when issuing a jumbo loan; so credit scores and debt-to-income ratios can influence how much cash reserves will be required. Higher credit and low DTI ratios show good creditworthiness and can result in lower cash reserve requirements. Anyone with a lower credit score and high DTI is a greater risk to a lender and can result in a requirement of more cash reserves.
Property type and location:
The property itself can affect how much cash reserves are required. Lenders typically require higher reserves for more volatile properties, such as investment homes, multi-unit buildings, or homes in fluctuating markets. A home that is your primary residence in a stable market typically requires fewer cash reserves.
Benefits of cash reserves for borrowers
Cash reserves provide lots of benefits for borrowers besides just being able to pay your bills on time:
Financial security
Higher cash reserves provide financial security that acts as a safety net in case of unexpected changes in a financial situation, such as job loss, medical costs, or family emergencies.
Lower interest rates
Having the reserves on hand can demonstrate financial stability and gain you a lower interest rate on the loan or more favorable loan terms overall. If you have more cash reserves saved than needed, you can even consider buying discount points (or mortgage points) to lower your interest rate even further to help you save over the life of the loan.
Flexibility in approval
Having higher reserves can allow more flexibility in approving the loan. The reserves help demonstrate a buyer’s ability to handle mortgage payments on time, making them more likely to get a loan even in stringent lending markets.
Challenges and considerations
Gathering up enough cash reserves for a jumbo loan comes with its share of challenges.
Impact on liquidity
Building a cash reserve can impact your financial liquidity, which will limit the amount of money you have available for other investments, emergencies, or purchases.
Strategic planning
Homebuyers should consider strategic financial planning to prepare for limited access to liquid funds. This can involve gradually accumulating savings and avoiding large and unnecessary purchases. Setting up automatic transfers to a savings account can help build reserves.
Alternatives to cash reserves:
If gradual saving is not an option, consider alternatives such as using retirement accounts, stocks, or other investments to meet the cash reserve requirements.
Practical advice and tips
Meeting cash reserve requirements for jumbo loans requires financial discipline, careful savings, and strong debt management. Buyers should aim to regularly add to a dedicated savings account, which will minimize discretionary spending. Once you have the reserves, you can use them to better negotiate the jumbo loan, including lower interest rates. Financial advisers can offer tips on maximizing spending and optimizing cash reserves for loan approval.
Disclaimer: Article content is intended for information only. It may not reflect the publisher nor employees’ views. Consult a mortgage professional before making financial decisions. Publishers or platforms may be compensated for access to third party websites.