What Is A Jumbo Loan, And How Do You Qualify for One?

Choosing the right mortgage is one of the most critical financial decisions when buying a home. It becomes more challenging when eyeing a high-value property that exceeds the loan limits set by the Bank of Canada, Canada Mortgage Housing Corporation (CMHC), or private lenders. While you can take multiple loans to finance your purchase; this will lead to mortgage complexities and higher borrowing costs.

Fortunately, you can finance your luxury home purchase using a jumbo loan that does not fall within the set limit. However, although it allows you to borrow more than a standard loan, it has strict qualification requirements that you must know beforehand. Therefore, here is what you should know about a jumbo mortgage and how to qualify.

What Is A Jumbo Loan?

A jumbo or non-conforming mortgage is a home loan that exceeds the loan limits set by the Canada Mortgage Housing Corporation (CMHC), the Bank of Canada, private mortgage insurers, and other government-sponsored entities. It is called a non-conforming loan because it does not follow the set borrowing rules, depriving it of the guarantees of conforming mortgages. As a result, a jumbo attracts more risks than a standard conforming mortgage, leading to greater scrutiny and higher borrowing costs. Jumbo mortgages can have fixed or adjustable rates, and their payment terms depend on the lenders.

They are also common in markets where house prices exceed national averages. In these cases, home buyers often need loans that can cover expensive properties and do not necessarily need backing from government or private entities.

Jumbo Loan Vs. Conforming Mortgages

The primary difference between jumbo and conforming loans is how the two mortgages work. Conforming mortgages follow the borrowing limits set by government-sponsored and private loan regulators. The Canadian bodies that set borrowing limits include the Canada Mortgage Housing Corporation (CMHC) and the Office of the Superintendent of Finance Institutions (OSFI). The two bodies, alongside other private entities, ensure that all mortgages are within the $1 million limit, although the amount can vary depending on the market and lender's criteria.

Financing a home priced above this limit requires a higher borrowing limit. In this case, a jumbo loan is ideal since it allows you to borrow more than the maximum amount conforming loans can give. Therefore, while both mortgages can have similar documentation and application processes, here are their key differences:

? Down payments: Most conforming loans have lower down payments of as low as 5% if you have mortgage insurance or backing. However, with jumbo loans, the minimum down payment is 20% of the home's value since they lack backing.

? Borrowing limits: The conforming mortgage limit in most Canadian provinces is around $1 million. On the other hand, those eyeing high-end homes can borrow more than $1 million.

? Interest rates: As of September 2024, the average mortgage rates in Canada range between 5.25% and 5.9% for fixed mortgages and 6.0% to 6.9% for variable mortgages. Jumbo loans have higher than the average national mortgage rates since they have higher risks to lenders.

How To Qualify for A Jumbo Loan in Canada

Since jumbo loans do not have backing from government and private entities, lenders will always require borrowers to be in good financial positions before granting them. They also want to ensure borrowers can repay the loans on time, even during economic hardship, to minimize the risks of mortgage defaults. Therefore, most lenders will look at the following factors before approving you for a jumbo loan.

1. Your Credit Score

The minimum credit score you need to qualify for a jumbo loan varies based on the lender, mortgage terms, and the current property value. In Canada, the average credit score you need to qualify for a jumbo mortgage is 700, although it can be as high as 760 or as low as 680. The higher the credit score, the higher the chances of securing a jumbo loan. Therefore, if you have a FICO score lower than 680, it is best to improve it through:

? Making timely payments on all pending debts.

? Avoid opening new credit lines.

? Correcting all errors on your credit report.

2. Debt-To-Income Ratio

Your debt-to-income (DTI) ratio shows how your gross income before tax compares to your total debts. To get your DTI, you divide your total outstanding debts by your gross income multiplied by 100. A higher DTI shows you will have challenges in repaying the mortgage, while a lower DTI means you are in an excellent financial position to make monthly payments.

The maximum DTI you need for a jumbo loan is 43%, although some Canadian lenders will require you to keep the ratio below 36%. You can reduce your DTI by lowering your home expenses and outstanding debts. This allows you to spend less than 36% of your gross income on monthly debt payments, including mortgages.

3. Down Payment and Cash Reserves

Since most lenders may worry about your ability to repay a jumbo loan, they may ask for proof that you can make a down payment and other mortgage repayments using the readily available cash. For this reason, they may ask for a down payment of at least 20% of the home's value. That means, for a home priced above $1 million, you will need to set aside more than $200,000 for a down payment.

You will also need enough cash in your bank account or liquid assets to cover at least 6-12 months of mortgage payments after closing. Moreover, most lenders will ask you to prove that you can pay all other house costs for at least six months, even during your critical financial time.

4. Property Appraisal

All lenders use the property appraisal report to determine how much mortgage you qualify for and the best interest rate to charge. However, with jumbo loans, most lenders will request a comprehensive property appraisal to mitigate the potential risks of higher loans. Some even ask for two appraisals, one from an independent appraiser, to ensure the property's value aligns with the loan.

5. Income And Employment Stability

Given the higher limits of jumbo loans, most lenders will assess your request based on your employment history and proof of income. They may want you to include your pay stubs, tax returns, and employment verification letters in your application. If you are self-employed, you may be required to include your bank statements, investment portfolio summaries, and proof of any other substantial assets.

The Bottom Line

Jumbo loans are a viable option for homebuyers looking to buy high-value properties that standard conforming loans cannot finance. These loans allow you to access a limit above the set $1 million, allowing you to buy your dream luxury home easily. However, they have strict qualification requirements and approval processes that can be challenging for low-income buyers. Therefore, before taking out a jumbo loan, it is advisable to consult your real estate advisor and understand your financial position to ensure you are ready for any commitment that comes with non-conforming loans.