We may receive payments from affiliate links included in this content. Our affiliate partners do not influence our opinions or editorial analysis. To learn more, see our Advertiser Disclosure.

When it comes to buying luxury real estate, cash may not be king anymore. Dropping money on a multi-million dollar house means locking up your cash flow. And with mortgage rates at historic lows, that money is probably better invested elsewhere, so financing might be the smarter option.

Buying a mansion with a jumbo mortgage is a little different than financing a modestly priced property using a traditional fixed rate loan. A jumbo mortgage comes with its own set of special rules, which we’ll walk you through to help you secure the purchase of that mansion.

What is a Jumbo Mortgage?

Most conventional mortgages are called “conforming loans,” so named because they conform to lending standards set by the Federal Housing Finance Agency (FHFA), which oversees loans from Fannie Mae and Freddie Mac. With conforming loans, lenders are protected against losses in the event of a borrower default.

Each year, the FHFA sets the maximum amount of loans that comply with single-family homes. In 2021, this cap is $ 548,250 for most regions of the country. However, in some areas with a higher cost of living (such as parts of California, Hawaii, and Washington, DC), compliant mortgage limits can be 150% higher (to a maximum of $ 822,375. ).

Mortgages that exceed these limits are referred to as “non-conforming conventional mortgages,” commonly referred to as jumbo loans. These loans are not guaranteed by the government and therefore are riskier for the lenders depending on the creditworthiness of the borrower. As such, underwriting standards are stricter than conventional loans.

Related: Check Jumbo Mortgage Rates in Minutes with Better

Giant mortgage requirements

Since jumbo mortgages do not fall under the FHFA, lenders can set their own criteria for approval. This often means that these loans can be more difficult to obtain.

First of all, you need good credit to qualify for a jumbo mortgage. Lenders typically require a score of at least 700 to borrow up to $ 1 million. For even larger loans, you may need a score between 720 and 760.

To make sure your credit is in good condition, you can get a copy of your credit reports from each of the three major bureaus (Experian, Equifax, and TransUnion) through AnnualCreditReport.com. Be sure to review your reports for any errors or negative items that need to be corrected before applying for a loan.

Lenders will also look at your debt-to-income ratio (DTI). This is a measure of how much of your gross monthly income is spent on debt repayment, expressed as a percentage. For example, if your income is $ 15,000 per month and you have credit card, student loan, and car payments totaling $ 4,500 per month, your DTI would be 30%.

Most mortgage lenders require your DTI ratio to be less than 43% when calculating all of your debt against your monthly income, including your mortgage payment.

Interest rates are exceptionally low right now, and jumbo loans are no exception. While the increased risk associated with a jumbo mortgage historically meant higher interest rates, this is not the case today. The 30-year average jumbo mortgage rate was just over 3% in early July, roughly the same cost of a compliant loan.

The adjustable rates for jumbo mortgages are a bit higher. For example, the Average Annual Rate (APR) of a 5/1 Variable Rate Mortgage (ARM), that is, the interest rate is fixed for the first five years and then becomes a variable rate for the remainder of the loan term. above 3.7% in June. Closing costs can also be higher, as taking out a jumbo loan comes with a higher administrative burden.

Lenders will generally require a substantial down payment of 20% or more for a jumbo mortgage. That means offering $ 200,000 in cash as a down payment for a $ 1 million house. Some lenders can take as little as 10% down, depending on the situation.

Jumbo loan alternatives

It is quite possible to finance a mansion with a jumbo loan. The real question is whether you should.

When you weigh the pros and cons of a jumbo loan, you need to keep cash flow in mind. A million dollar mortgage with a term of 15 years and an interest rate of 3% would mean you have to pay over $ 5,700 per month. If your income is unpredictable and you don’t have a ton of cash reserves, you might find yourself mixing up your finances to make the payments.

You may decide that you are better off using another financing option. For example, depending on the price of the property, you may be able to use a piggyback loan instead. This allows you to take out two smaller mortgages instead of a jumbo loan.

A common piggyback loan structure is the 80/10/10. This means you take out a mortgage for 80 percent of the amount you want to finance, then borrow an additional 10 percent using a second loan, and provide a down payment for the remaining 10 percent. It also allows you to avoid paying for private mortgage insurance, which lenders may require to protect you against defaulting on a loan.

Keep in mind that you will still need to factor the payments into your monthly cash flow and keep track of two loans instead of one.

Another option is to offer a much larger down payment, such as 50 percent or more. This can help you borrow less and meet compliant loan limits, resulting in lower rates and fees as well as lower monthly payments. Again, you’ll need to consider whether it’s better to use your money for a down payment, use it to pay off high-interest debt, or invest it while saving more.

When it comes to buying luxury real estate, you have a lot of options. The key is to calculate the numbers by figuring out how to best use your money and how you can use low interest debt to your advantage.

Casey Bond is a seasoned personal finance writer and editor. In addition to being published in Forbes, his work has appeared on HuffPost, Business Insider, Yahoo! Finance, MSN, The Motley Fool, US News & World Report, TheStreet and more. Follow her on Twitter @CaseyLynnBond.