The housing market has faced extraordinary turmoil over the past few years. As the COVID-19 pandemic took hold, the market turned white-hot as the demand for housing significantly outpaced supply. Naturally, this had a major impact on inventory, which at one point resulted in the average home being on the market for mere days. This frenzy also prompted a sizable spike in bidding wars among active buyers.
More recently, the housing market has slowed somewhat and price growth has cooled a bit. But despite the ravages of high interest rates and inflation, home prices had not declined in any meaningful way as of this past spring. In fact, according to one estimate, the share of homes valued at more than $1 million has nearly doubled since the start of the pandemic to a rate of one in 14 homes.
“The number of million-dollar homes in the U.S. has risen substantially. In 2015, there were approximately 2 million homes worth $1 million or more. By 2021, this figure had grown to 4.2 million homes.”
The availability of jumbo mortgages has helped to fuel the growth of the luxury home market in several ways. For one, it has allowed buyers to access the funds they need to purchase high-end homes without having to rely on personal savings or other sources of financing. This has made it easier for individuals and families to enter the luxury home market, which was previously reserved for only the wealthiest buyers.
In addition, jumbo mortgages have helped to spur the development of new luxury homes and communities. Developers are more likely to take on these projects when they know there are plenty of buyers who can afford to purchase them. The availability of jumbo mortgages has therefore created a virtual cycle in which the growth of the luxury home market has led to more demand for jumbo mortgages, which in turn has led to more development of luxury homes and communities.
The number of million-dollar homes in the U.S. has risen substantially. In 2015, there were approximately 2 million homes worth $1 million or more. By 2021, this figure had grown to 4.2 million homes, according to census data. Although luxury home sales plunged on a yearly basis this past winter, they increased from February to March by nearly 50%. The Institute for Luxury Home Marketing expects prices and demand to fluctuate in the near future as the economy shakes out.
Still, the million-dollar home market has grown significantly over the past few years. About 7% of all homes in the U.S. were valued at $1 million or more in January, according to Redfin. That’s down from an all-time high of 8.6% in June 2022, but it’s much higher than the 4.2% pre-pandemic rate. In the areas with the largest numbers of million-dollar homes, the percentage increases have been staggering.
“The primary advantage of a jumbo mortgage is that a borrower can qualify for a larger loan amount, which means they can purchase a more expensive home without having to come up with additional cash.”
The highest concentrations of million-dollar homes are in the states of California, Hawaii, Washington, New York and Massachusetts. In California and Hawaii, about 23% of all homes are worth $1 million or more. In the Pacific Northwest, million-dollar homes are most prevalent in the Seattle area and the surrounding suburbs of Bellevue and Kirkland. In Bellevue, 60% of homes are priced at $1 million or more, while in Seattle, the share is 33%.
While these are eye-popping numbers, there are three cities in California with even higher concentrations of million-dollar homes. In Pleasanton, Sunnyvale and San Francisco, these percentages exceed 70%. With such a dramatic increase in recent years in the number of million-dollar homes, the question becomes, who is buying these homes, how are they being financed and how is this trend affecting the housing market at large?
Of course, buyers come in all shapes and sizes, and their capacity to afford a million-dollar home depends on their personal financial circumstances. For example, an individual or couple might generate a substantial income but not have much in the way of a downpayment. Conversely, a buyer might have a large downpayment while earning less monthly income.
If you assume a standard downpayment of 20% (which amounts to $200,000 on a million-dollar home purchase), then the buyer would have a mortgage balance of $800,000. If you further assume that their mortgage balance should not exceed 25% of their pretax income, then a household would have to generate at least $200,000 annually to support their purchase.
Most Americans do not earn $200,000 or more per year. As a result, there is often a differential in some areas between the number of available million-dollar homes and the number of households that can afford them.
Despite this affordability gap, many housing analysts expect the share of million-dollar homes to continue to grow. They attribute this trend to an influx of wealthy buyers seeking to invest in luxury properties, as well as a steady rise in property values in certain affluent areas of the country.
Every year, the Federal Housing Finance Agency (FHFA) determines the conforming loan limits for mortgages to be acquired by Fannie Mae and Freddie Mac. In 2023, the loan limit for single- unit properties is $726,200 in most areas of the U.S., an increase from $647,200 in 2022.
In designated higher-cost regions of the country, the new ceiling for one-unit properties is $1,089,300, or 150% of $726,200. Practically speaking, in most parts of the U.S., buyers who want to purchase a luxury home ($1 million or more) with a conforming loan are precluded from doing so because of the existing loan limits of $726,200. In all likelihood, these buyers will seek out a jumbo loan to fund their purchase. Jumbo loans exceed the FHFA guidelines and cannot be purchased by Fannie or Freddie.
Even in the designated higher-cost regions of the country, buyers who wish to purchase a higher-priced luxury home (say $1.5 million and above) are also likely to fund their purchase with a jumbo loan, given the new limit of $1,089,300. The primary advantage of a jumbo mortgage is that a borrower can qualify for a larger loan amount, which means they can purchase a more expensive home without having to come up with additional cash for a downpayment or closing costs.
Additionally, jumbo loans often come with competitive rates and some may even have lower rates than conventional loans. That’s because lenders are less exposed to risk since they don’t have to meet certain requirements set by Fannie Mae or Freddie Mac. Here are some other general guidelines for jumbo loans:
- Minimum downpayment of at least 10%, although some lenders require up to 30%.
- Minimum credit score of at least 700, although some lenders have a higher interest rate option for borrowers who fall just short.
- Debt-to-income ratio varies by lender, but it’s typically 38% to 43%.
- Cash reserves of six to 18 months can be required of the borrower.
For borrowers who need a loan that is higher than the federal limits, who are high-income earners, have extremely strong credit and wish to finance a luxury home (or a home in a highly competitive area), they should seek out a jumbo loan from a qualified mortgage lender. It is the financing option that will most likely make the purchase of their dream home possible.
Jumbo loans recently experienced an uptick in borrower demand due to their favorable interest rates, according to Black Knight. The pressures of escalating mortgage rates and the affordability of homes combined to drive down the number of rate locks in February 2023 compared to the previous month.
Actual dollar volume rose, however, because borrowers took advantage of the preferred rates for jumbo loans and adjustable-rate mortgages (ARMs). As rates remain elevated, borrowers have responded predictably by moving toward more advantageously priced offerings. This includes a shift to jumbos, ARMs and other nonconforming products.
Overall, the availability of jumbo mortgages has been a positive development for the luxury home market. It has allowed more individuals and families to enter this segment and has helped to spur the development of new luxury homes and communities. As the real estate industry continues to evolve and grow, it is likely that jumbo mortgages will continue to play an important role in the purchase of higher-priced homes. ●