Avoiding Jumbo Loans By Combining a Conforming Loan and Second Loan

Conforming loans are those that satisfy the criteria that Fannie Mae and Freddie Mac set regarding what kinds of loans they will buy. Besides certain credit-related guidelines like debt-to-income ratio, one major constraint is the maximum loan amount. Barring any upcoming changes (see below), the current limits are $417,000 in the continental US (AK, HI get $625,500).

Because they can be so readily sold to these psuedo-government entities, conforming loans are usually very competitively priced. Non-conforming loans have to be sold elsewhere or kept in-house, so they usually end with higher rates. But as recently as July 2007, the added cost for a non-conforming loan might have been only 0.20%. However, due to rising default rates and skeptical investors, the premium is currently around a full 1%. This has led to the increasing popularity of replacing a jumbo loan with two loans – a conforming one and a second loan to make up the difference.

Example. Let’s say you wanted to buy a $600,000 home, with a 20% down payment ($120,000). This leaves $480,000 to be financed, which is over the $417,000 conforming cap. With a single Jumbo loan, here’s your scenario. (I’ll use estimated mortgage rates based on current market conditions.)

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But, here’s what happens when you split it up into a $417,000 conforming loan and a $63,000 second loan. The second loan usually has a higher interest rate, similar to that of a home equity loan.

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By restructuring, you have lowered your effective interest rate nearly 50 basis points .from 6.5% to 6.01%, which in turn lowered the mortgage payment by $127 a month ($1,524 a year). To find the blended rate, I used the this Dinkytown calculator.

The Fine Print:

  • This works best with small 2nd loans. Kind of obvious, but the less you have to put on the 2nd loan with higher interest, the better your blended rate would be. As the loan amount rises, there will likely be a point when the plain Jumbo loan will give you the lower payment.
  • The second loan can be structured in a variety of ways. It could be a completely separate loan from a different lender, it could be a home equity loan from the same lender, or it could be a home equity line of credit.
  • You might have balloon payments. In my case, I was offered a equity loan amortized over 30 years, but with a balloon payment due after 15 years. So I would need to either pay off that $63,000 within 15 years, or refinance before then.
  • Possibly higher closing costs. The second loan may incur closing costs, but they should be a lot smaller than the first loan because things like appraisals have already been paid for.
  • Conforming limits might change soon! The pending economic stimulus package legislation – which is almost on Bush’s desk as I type – proposes to temporarily raise the conforming limits to as high as $729,750 in “high cost” areas based on median home price. It is unknown how soon this will take effect, but probably too late for me. (Google News)

Comments

  1. FYI, congress just passed the stimulus package yesterday which increases Jumbo starting limits from 417K to 730K. I am not sure when this goes into effect, but it might be worth checking out.

  2. Oops, just read the last paragraph of your post and you already are on top of it. Good post as usual.

  3. you didn’t take into account the tax-deductibility of mortgage interest. the 2nd loan’s interest is not tax-deductable. Depending on your tax bracket, it can make some difference.

  4. I needed that blended rate calculator. I had a rough estimate for my 2 combined loans (5.625% and 7.25%) at around 5.9% but now I know exactly what it is (5.8825). I wasn’t so far off but this is good to know when considering refinancing to 1 loan and trying to determine if the rate is low enough to justify the cost of the re-fi. Thanks.

  5. Ted Valentine says:

    This shouldn’t be an issue for you. I’m sure you’ll pay off that second loan in 12 months or less.

  6. It’s interesting to see you go through this because you’re pretty much describing what I went through but for different reasons. I did 2 loans to avoid PMI (I only put 5% down) and the 2nd loan is amortized over 30 years with a balloon payment at then end of 15 years. To address that, I pay extra on the 2nd loan every month (I consider it a good idea because it’s like saving money at a 7.25% rate which you can’t get close to these days).

    The 2nd loan did come with it’s own closing costs too but they were small and the person I bought the house from paid a nice chunk of my closing costs anyway as agreed to in the contract.

  7. Thanks — I always wondered how those 2 part loans were done. Do you get a discount on closing costs (or any interest discount) if you use the same lender for both? Even if the conforming limit goes up, the interest rates may take in to account the additional risk, so you probably wouldn’t do much better.

  8. Melbourne homes for sale says:

    So it looks to me like this conforming loan is better for all than the stimulus package to increase the Jumbo loan.

    Well there is our answer the president will increase the Jumbo loan and again not serve the people. Is he even aware this is an option. I’m sorry I realize you can’t answer this but seems like there are ways to resolve the situation.

    Thanks for your update very informative.

  9. Nice post timing.

    My wife and I are in this exact situation right now. What it looks like we’ll do is what you did: 1st mortgage on $417k at low rate; 2nd mortgage on conforming amount at higher rate, but with balloon payment after 10 years.

    However, want to see what the stimulus package does for us, though our area (Texas) will likely not be affected for the bump in the $417k level.

  10. I do the same Robert. I been making extra payment on my 2nd loan every payment. Conforming loan limit increases for duplex and triplex, which is great, being able to attain a higher asset at a conforming rate.

  11. Was the reduction in the mortgage interest tax deduction included in the analysis. Just to cover all the bases, it would be interesting to see what impact over the long run that 1500+ in yearly savings has on your deduction allowances, especially once you figure in the added closing costs of another loan.

  12. Tax-deductibility is another loooong and complicated topic. Again, the structure of the 2nd loan may matter.

    But in my example it is a home equity loan for $63,000, so why is that not tax-deductible? I have less than $1,000,000 of home acquisition debt, and less than $100,000 of home equity debt.

  13. What I was alluding to is the fact that you are paying less in interest each year with a alternate loan arrangement. That is where you lose a deduction (decreased amount of the deduction), not that the new loan arrangement somehow does not qualify. I understand that the difference is not huge but it is real, and the higher your marginal rate the larger the difference. If the difference in interest paid were say 1000/year, depending on your marginal rate, the savings would be reduced by 280 to 350, again depending on your rate.

  14. Moneyandpf says:

    Thanks for the info on this. I’m not all that familiar with mortgages and it’s good to learn about this subject. I’ll be buying a home within the next 2-3 years and even though it probably won’t be enough to be considered a jumbo loan it will be nice to know if the future.

  15. I think it was another person above (Winston) who said it wasn’t tax deductible.

    But in your case, I see what you’re saying, you’re talking about the specific savings amount being less. That’s highly dependent on itemization and/or tax bracket, but yes I agree there will be a difference. My main point was that the two-mortgage option is still definitely the better choice.

  16. This is a quick assumption, but the savings difference would probably be essentially the same as going with a mortgage with a 6% rate vs. a mortgage at 6.5%.

  17. It’s deductible, no question about it. You’d find it interesting to hear tax preparers compare clients’ stories about what they can deduct or what their tax should be and why. “My co-worker got back $3,000, so why can’t i get the same amount?”.

  18. I used this technique a few years ago when I bought my place to save over half a percent over a jumbo loan when looking at the overall blended rate.

    Even with the increases, there are a number of people in the San Francisco Bay area as well as Los Angeles and San Diego that can still use this technique to their advantage.

  19. This is exactly what I’m looking at if the limits for conforming loans increase where I live. I currently have a jumbo 30 year fixed rate mortgage at a great rate (5.625%). But if the conforming limits go up and I can get a 15 year mortgage in the 4.5 to 4.75% range, I’ll refinance.

  20. Now you are talking about a problem that affects only the get rich people. I bought my house for about $100,000.
    It is people like you who have inflated the house prices and are the root cause of the current looming depression and sub prime lending.
    I am in the process of applying a HLOC because many lenders are offering me with no closing cost at all. My house is already paid up and I do not have a need for any mortgage at all.

  21. The graphics are great (I’m a visual learner). Keep up the good work…

  22. maryann says:

    I have a VERY serious problem I could REALLY use some help with, I am going to send this to you and PRAY you can get back with me before my blood pressure makes me have a heart attack.

    Ok this is the deal, I sold a property to a guy on contract threw escrow with HIM paying the exact payment on the loan for 4 years IF he could NOT pay off the loan it would come back to ME. he gave me $10,000 down and than we signed that contract threw the escrow holding HIM responsable for the payment etc for those 4 years and than back to ME if he couldnt,

    well, he asked me for MORE time on the note cause he was having problems (that was like 3 months ago) i told my husband we COULD ONLY if he would sign on the contract saying that he would NOT strip the house if he DID loose it back to us. he said “well I dont know if I can do that”. so we said “well, talk it over with your wife and let us know”! and we left without any of us signing another further to the contract.

    well, today he called me, the contract to HIM is UP in August. and he is freaking out because HE cannot get a loan from the bank for it AND than he asked me AGAIn to give him more time, upon talking with him about selling it for what is owed ont he place which SHOULD be $60,000 (it appraised at $140,000.00 and HE is TRYING to sell it at $225,000 with him getting a down for 20% and than carrying it for the people he will pay us off he said. ok well he is NOT going to get that so he CALLED the bank and tried to get a new loan to which they said NO. I than said “well than tell ME what you exactly want so we can tell some of the guys that my husband works with MAYBE one of them would buy it if you are willing to let it go with JUST your money in it, and than he told me
    “WELL< thats the thing Maryann I took out a second on the house for $75,000.00 and there is a lean on the property from the hard money lender for $75,000.00 so not only now do I owe YOU the $60,000 we owe the hard money lender the $75,000.00 and so if you didnt give me the time and you ended back up with the property than you wouldnt be able to do anything with it cause there is a second on it for that $75,000.00
    I did NOT agree with this and I tolld him HOW could he do that? and he said “well it didnt say in the contract that I couldnt do that”. but it didnt say he COULD ETHER!!!

    ok this is the deal CAN HE DO THAT AND am I responsable to this hard money lender? can he keep something from me??

    I put up a business to get this loan and can easily pay back that $60,000 to ME (which to I will have six months to do so after I get it back from HIM I have a baloon payment I can pay back but, what about this other guy, can HE take the land I put up as calatoral? or even can he have a lean on my house I didnt sign ANYTHING with this hard money lender to ALLOW him to loan that money and I was not contacted in anyway that this guy was going to do this. please tell me what my options are here. he has a 10 day late period on the note (in the contract and has been late MANY times on the note to which we have NOT steped in and took the property back) and for him to try to screw me like this now really pisses me off and I want to know if he can even do all this that he said he did. this guy has about 50 more houses around town. to which I KNOW he had to put the $75,000 money into he borrowed from the hard money lender NOT this property. please please please tell me if this is legal what he did..

    thank you Maryann
    ANYONE PLEASE Email ME BACK AT wesfamily@msn.com with your answer direct if you read this I REALLY need an answer and not sure how I got here even. but I REALLY need help please email me your answer PLEASE!!

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