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A jumbo loan is a home mortgage loan that exceeds maximum dollar limits set by the Federal Housing Finance Agency (FHFA). Loans that fall within the limit are called conforming loans. Loans that exceed them are jumbo loans.

Jumbo mortgages may be needed by buyers in areas where housing is expensive, and they’re also popular among lovers of high-end homes, investors, and vacation home seekers.

What Is a Jumbo Loan?

To understand jumbo home loans, it first helps to understand the function of Freddie Mac and Fannie Mae. Neither government-sponsored enterprise actually creates mortgages; they purchase them from lenders and repackage them into mortgage-backed securities for investors, giving lenders needed liquidity.

Each year the FHFA sets a maximum value for loans that Freddie and Fannie will buy from lenders — the so-called conforming loans.

Jumbo Loans vs Conforming Loans

Because jumbo home loans don’t meet Freddie and Fannie’s criteria for acquisition, they are referred to as nonconforming loans. Nonconforming, or jumbo, loans usually have stricter requirements because they carry a higher risk for the lender.

Jumbo Loan Limits

So how large does a loan have to be to be considered jumbo? In most counties, the conforming loan limits for 2023 are:

•  $726,200 for a single-family home

•  $929,850 for a two-unit property

•  $1,123,900 for a three-unit property

•  $1,396,800 for a four-unit property

The limit is higher in pricey areas. For 2023, the conforming loan limits in those areas are:

•  $1,089,300 for one unit

•  $1,394,775 for two units

•  $1,685,850 for three units

•  $2,095,200 for four units

Given rising home values in many cities, a jumbo loan may be necessary to buy a home. Teton County, Wyoming, for instance, has an average home value of $1,624,087 and a conforming loan limit of $1,089,300.

Recommended: The Cost of Living By State

Qualifying for a Jumbo Loan

Approval for a jumbo mortgage loan depends on factors such as your income, debt, savings, credit history, employment status, and the property you intend to buy. The standards can be tougher for jumbo loans than conforming loans.

The lender may be underwriting the loan manually, meaning it’s likely to require much more detailed financial documentation — especially since standards grew more stringent after the 2007 housing market implosion and during the pandemic.

Lenders generally set their own terms for a jumbo mortgage, and the landscape for loan requirements is always changing, but here are a few examples of potential heightened requirements for jumbo loans.

•  Your debt-to-income (DTI) ratio. This ratio compares your total monthly debt payments and your gross monthly income. The figure helps lenders understand how much disposable income you have and whether they can feel confident you’ll be able to afford adding a new loan to the mix.

To qualify for most mortgages, you need a DTI ratio no higher than 43%. In certain loan scenarios, lenders sometimes want to see an even lower DTI ratio for a jumbo loan, or they may counter with less favorable loan terms for a higher DTI.

•  Your credit score. This number, which ranges from 300 to 850, helps lenders get a snapshot of your credit history. The score is based on your payment history, the percentage of available credit you’re using, how often you open and close accounts such as credit cards, and the average age of your accounts.

To qualify for a jumbo loan, some lenders require a minimum score of 700 to 740 for a primary home, or up to 760 for other property types. Keep in mind that a lower score doesn’t mean you won’t be able to get a jumbo loan. The decision depends on the lender and other factors, such as the loan program requirements, your debt, down payment amount, and reserves.

•  Down payment. Conforming mortgages generally require a 20% down payment if you want to avoid paying private mortgage insurance (PMI), which helps protect the lender from the risk of default.

Historically, some lenders required even higher down payments for jumbo mortgages, but that’s not necessarily the case anymore. Typically, you’ll need to put at least 20% down, although there are exceptions.

A VA loan can be used for jumbo loans. The Department of Veterans Affairs will insure the part of the loan that falls under conforming loan limits. The down payment requirement is based on the portion of the jumbo loan that’s above the conforming loan limit. The loan is available from some lenders with nothing down and no PMI. VA loans have a one-time “funding fee,” though, a percentage of the amount being borrowed.

•  Your savings. Jumbo loan programs often require mortgage reserves, housing costs borrowers can cover with their savings. The number of months of PITI house payments (principal, interest, taxes, insurance), plus any PMI or homeowner association fees, needed in reserves after loan closing depends on many factors. For a jumbo loan, some lenders may require reserves of three to 24 months of housing payments.

You don’t necessarily need to have all the money in cash. Part of mortgage reserves can take the form of a 401(k), stock portfolios, mutual funds, money market accounts, and simplified employee pension accounts.

Also, depending on the loan program, a lender may be comfortable with lower cash reserves if you have a high credit score, low DTI ratio, a high down payment, or some combination of these things.

•  Documentation. Lenders want a complete financial picture for any potential borrower, and jumbo loan seekers are no exception. Most lenders operate under the “ability to repay” rule, which means they must make a reasonable, good-faith determination of the consumer’s ability to repay the loan according to their terms. Applicants should expect lenders to vet their creditworthiness, income, and assets.

Jumbo Loan Rates

You might assume that interest rates for jumbo loans are higher than for conforming loans since the lender is putting more money on the line.

But jumbo mortgage rates fluctuate with market conditions. Jumbo mortgage rates can be similar to those of other mortgages, but sometimes they are lower.

Because the absolute dollar figure of the loan is higher than a conforming loan, it is reasonable to expect closing costs to be higher. Some closing costs are fixed, such as a loan processing fee, but others, such as title insurance, are tiered based on the purchase price or loan amount.

Pros and Cons of Jumbo Loans

Benefits

Because a jumbo loan is for an amount greater than a conforming loan, it gives you more options for ownership of homes that are otherwise cost-prohibitive. You can use a jumbo loan to purchase all kinds of residences, from your main home to a vacation getaway to an investment property.

Drawbacks

Due to their more stringent requirements, jumbo loans may be more accessible for borrowers with higher incomes, strong credit scores, modest DTI ratios, and plentiful reserves.

However, don’t assume that jumbo loans are just for the rich. Lenders offer these loans to borrowers with a wide variety of income levels and credit scores.

Lender requirements vary, so if you’re seeking a jumbo loan, you may want to shop around to see what terms and interest rates are available.

The most important factor, as with any loan, is that you are confident in your ability to make the mortgage payments in full and on time in the long term.

How to Qualify for a Jumbo Loan

To qualify for a jumbo loan, borrowers need to meet certain jumbo loan requirements. You’ll likely need to show a prospective lender two years of tax returns, pay stubs, and statements for bank and possibly investment accounts. The lender may require an appraisal of the property to ensure they are only lending what the home is worth.

Is a Jumbo Loan Right for You?

You’ll need to come up with a large down payment on a property that merits a jumbo loan, and some of your closing costs will be higher than for a conventional loan. But depending on where you wish to buy, the cost of the property, and the amount you wish to borrow, a jumbo loan may be your only choice for a home mortgage loan. It’s a particularly attractive option if you have good credit, a low DTI, and a robust savings account. And sometimes jumbo home loans actually have lower interest rates than other loans.

What About Refinancing a Jumbo Loan?

After you’ve gone through the mortgage and homebuying process, it could be helpful to have information about refinancing. Some borrowers choose to refinance in order to secure a lower interest rate or more preferable loan terms.

This could be worth considering if your personal situation or mortgage interest rates have improved.

Refinancing a jumbo mortgage to a lower rate could result in substantial savings. Since the initial sum is so large, even a change of just 1 percentage point could be impactful.

Refinancing could also result in improved loan terms. For example, if you have an adjustable-rate mortgage and worry about fluctuating rates, you could refinance the loan to a fixed-rate home loan.

Recommended: Guide to Buying, Selling, and Updating Your Home

Jumbo Loan Limits by State

The conforming loan limits set by the Federal Housing Finance Agency can vary based on the county where you are buying a home.

In most areas of the country, the conforming loan limit for a one-unit property increased to $726,200 in 2023 (the amount rises for multiunit properties). The chart below shows exceptions to the $726,200 limit by state and county.

Source: Federal Housing Finance Agency

The Takeaway

What’s the skinny on jumbo loans? They’re essential for buyers of more costly properties because they exceed government limits for conforming loans. Luxury-home buyers and house hunters in expensive counties may turn to these loans, but they’ll have to clear the higher hurdles involved.

If you’re interested in refinancing a jumbo mortgage at competitive rates, consider SoFi. You can prequalify online and put as little as 10% down.

With SoFi, you can see your new rate in just minutes.

FAQ

What are jumbo loan requirements?

Jumbo loans typically require a credit score of at least 700, a low DTI, and a down payment of at least 20%, although there are always exceptions.

What is the difference between a jumbo loan and a regular loan?

A jumbo loan is a home mortgage loan that exceeds maximum dollar limits set by the Federal Housing Finance Agency. Jumbo loans are typically used by buyers in regions with higher-priced housing but are also popular among luxury homebuyers and investors.

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SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

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Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility for more information.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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A trust can simplify the transfer of what is often a person’s most valuable asset: their real estate. It can keep a home out of the probate process and allow it to become the property of loved ones or a charity upon your death.

For many households, home equity represents their largest financial asset, and it has burgeoned. U.S. homeowners with mortgages saw their equity increase by $1 trillion at the end of 2022 compared with a year before, according to CoreLogic, a provider of property insights.

Here, a closer look at protecting one’s assets by putting a house into a trust.

Why Put a House in a Trust?

There are two main reasons: avoiding the probate process and protecting your property if you become incapacitated.
Put simply, probate is a court review of a deceased person’s will and assets. This involves resolving any claims against the estate, paying remaining debts, and distributing the decedent’s assets to their designated heirs.

Probate can be a lengthy and costly process. In the absence of a will, the probate court divides the estate according to the state’s succession laws. These proceedings often require hearings and a variety of legal and court fees, which can significantly chip away at the estate before it reaches the heirs.

Even with a will in place, probate is often necessary for your heirs to have the right to carry out your will. Things can become further complicated if the estate includes property in multiple states or the will is contested.

Putting property in trust can avoid probate altogether. A trust designates a successor trustee to manage the estate, as well as beneficiaries to receive assets, after your death. The trust can include clear instructions and conditions for allocating assets. This can help reduce the time and cost to pass your home to your heirs.

It’s also worth noting that trusts can safeguard assets if you become incapacitated and are unable to care for yourself. A trust can be created to take effect in this situation, thus allowing a family member or loved one to manage your estate and assets in your best interests. If you recover, you can resume the role of trustee for the estate.

Recommended: What Is a Trust Fund?

Do You Need a Trust If You Have a Will?

Only one in three U.S. adults has a will, according to one recent report. And even if you have created one, you may wonder whether you are handling your assets properly. For instance, you may ask yourself, “Should I put my house in a trust?” The answer will depend on your own financial goals and the needs of your heirs.

Who you intend to inherit your house is an important factor to consider. Federal estate and gift tax law permits the transfer of a house and other wealth to a spouse without tax liabilities. However, passing on a house to children or relatives of a subsequent generation can be more complex.

A trust goes into effect once you sign it and is generally more difficult to challenge than to contest a will. Placing a house in a trust also avoids the probate process — it’s not uncommon for the courts to take months or a year to settle a will, especially for larger estates.

Wills and trusts can be complementary tools for estate planning. For instance, a will can take care of smaller assets like family heirlooms that aren’t covered by the trust. Also, wills can be structured to move assets into a trust when you die.

💡 Quick Tip: Buying a home shouldn’t be aggravating. SoFi’s online mortgage application is quick and simple, with dedicated Mortgage Loan Officers to guide you through the process.

Types of Trusts for Estate Planning

There are multiple options available for putting your house in a trust. It’s important to consider financial goals, your beneficiaries’ needs, and creditor concerns when creating a trust.

Here’s an overview of common types of trusts, including how they work for passing on a house or other property. The basic kinds are revocable and irrevocable and they are typically part of an estate planning checklist.

Revocable Trust

Also known as a living trust, a revocable trust gives grantors more control in the management of their assets while alive. They’re still responsible for tax payments and reporting on investment returns.

If desired, a grantor can make changes or dissolve a revocable trust after it’s created. Getting remarried or buying a home could be possible reasons for altering a revocable trust.

Usually, the grantor (establisher) serves as the trustee (manager for beneficiaries), and a named successor only takes control if that person dies or becomes incapacitated.

A revocable trust becomes irrevocable upon the grantor’s death. A revocable trust does not protect a house and other assets from creditors while the grantor is alive.

Irrevocable Trust

An irrevocable trust differs in that it can’t be modified by the grantor without the approval of all beneficiaries. You effectively give up control and ownership of any assets placed in an irrevocable trust.

So why put your house in a trust with such rigid conditions? Irrevocable trusts can offer greater security for beneficiaries and render assets untouchable to creditors. Plus, you’re not subject to estate taxes because the assets are no longer yours.

Before permanently forfeiting assets to an irrevocable trust, it could be beneficial to consult a lawyer or find a financial planner.

Recommended: Average American Net Worth by Age and Year

Other Types of Trusts

Aside from the two broad categories of trusts, there are more specialized options to address specific needs. Here are some additional types of trusts to consider.

• Charitable Trust: This type of trust transfers assets to a designated nonprofit organization or charity upon the grantor’s death. A charitable trust can be housed within a standard trust to allocate a portion of assets to a nonprofit while leaving the rest for family members or other heirs.

• Testamentary Trust: A trust can be created within a will, often for minors, with defined terms that take effect after your death. This is a type of revocable trust, as changes can be made up until death. It’s worth noting that a testamentary trust does not avoid probate court. The executor will probate the will and then create the trust.

• Generation-Skipping Trust: Instead of passing on a house to your children, you can use a generation-skipping trust to transfer assets to your grandchildren. This is more common for estates that exceed the federal estate tax threshold ($12.92 million in 2023) to avoid some estate tax payments down the line.

• Spendthrift Trust: If you’re concerned about how your beneficiaries will manage their inheritance, you can use a spendthrift trust to set stricter terms. For example, you could define a date or age when beneficiaries gain access to certain assets.

💡 Quick Tip: There are two basic types of mortgage refinancing: cash-out and rate-and-term. A cash-out refinance loan means getting a larger loan than what you currently owe, while a rate-and-term refinance replaces your existing mortgage with a new one with different terms.

Should I Put My House in a Trust?

It’s important to understand the implications of having a house in trust before making a binding decision. Here, the main advantages and drawbacks.

Benefits of a Trust

Bypassing the hassle, delays, and costs associated with probate is a leading reason for using a trust.

Probate expenses can vary by location and the size of the estate but traditionally include legal fees, executor fees, appraisal fees, and other administrative costs. While probate costs will vary depending on the size of the estate and the state you live in, they can often be 4% to 7% of the estate or more.

You may also want to avoid probate to keep the details of your estate private. Probate is a public process that can reveal your estate’s worth and chosen beneficiaries.

Trusts are also useful tools for providing a financial safety net for children in the unexpected event that both parents die. A trustee manages the assets on behalf of any minor beneficiaries. Terms can be set to transfer control of assets held in the trust to children when they reach a certain age.

Putting certain assets in a trust could help some seniors qualify for Medicaid. If you’re 65 or older, your home and furnishings are usually exempt from the asset limit to qualify, but the threshold is low: around $2,000 in most states.

Disadvantages of a Trust

Setting up a trust can be complex. There are usually more costs in creating a trust than a will.

With a revocable trust, you need to track income from assets held in the trust to report on your personal tax returns. If you designate a third-party trustee to manage the trust, maintenance costs could add up over time.

And if you put just your home in a trust, your other assets will still be subject to the probate process.

When a house is the only large asset, buying a house from a family member is a possible alternative. Though this can be contentious among relatives, it’s another option to pass on a valuable asset to the family while providing some financial security.

The Takeaway

Estate planning isn’t always easy. Putting your house in a trust is one strategy to reduce the time and costs associated with inheritance. Probate costs can eat up 4% to 7% of an estate, and putting assets into a trust can help avoid that. Even if you put a house in a trust, however, you are still liable for any mortgage payments due, which you may be able to lower via refinancing.

Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.

SoFi Mortgages: simple, smart, and so affordable.

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Photo credit: iStock/BrianAJackson

*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

This article is not intended to be legal advice. Please consult an attorney for advice.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility for more information.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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A Direct Consolidation Loan combines federal student loans into a single loan with one monthly payment. If you have multiple federal student loans, this could be one way to simplify the repayment process and more easily stay on top of student loan payments. With a Direct Consolidation Loan, you are also eligible for student loan forgiveness and income-driven repayment programs.

A Direct Consolidation Loan, however, doesn’t typically lower your interest rate. Instead, this type of loan is geared toward borrowers who want to streamline their monthly payments or qualify for loan forgiveness, as opposed to borrowers who want to save money on interest.

While consolidation of student loans can lower your monthly payment by extending your repayment timeline, you typically end up paying more overall due to the additional interest you pay when lengthening your loan term. Before you commit, make sure to run the numbers and consider the pros and cons of a Direct Consolidation Loan.

Is a Direct Consolidation Loan a Good Idea?

Deciding if student loan consolidation is right for you depends on whether your desire to simplify your payments outweighs the potential loss of some benefits.

Pros of Direct Consolidation Loans

Can simplify repayment: The first thing to consider is if you currently have multiple federal student loans with different servicers, meaning you have to log in to two or more separate accounts to pay your student loan bills each month. In this instance, consolidation can make life a little easier because the process will give you a single loan with a single bill each month.

Can lower your monthly payments: Consolidation can also lower your monthly payment amount by giving you up to 30 years to repay your loan or by giving you access to income-driven repayment plans. Keep in mind, though, that by extending your loan term and reducing your monthly payment, you will end up paying more in interest over the life of the loan.

Can allow you to switch from a variable to a fixed rate: If you have any variable-rate loans, consolidation will make it so you can switch to a fixed interest rate.

Can make loans eligible for forgiveness: If you consolidate loans other than Direct Loans, such as Perkins Loans (drawn before the program was discontinued), those loans may become eligible for Public Service Loan Forgiveness (PSLF) once consolidated.

Recommended: Fixed vs. Variable Rate Loans

Cons of Direct Consolidation Loans

Can lead you to make more payments and pay more in interest: When you consolidate your federal loans, your repayment period will be extended between 10 and 30 years. This means you will make more payments and pay more in interest, unless you switch to a different student loan repayment plan.

Can make you lose some benefits: Consolidation can also cost you some benefits that only non-consolidated loans are eligible for, such as access to some loan cancellation options. It’s a good idea to check in with your loan program before opting for a Direct Consolidation Loan.

Can cause you to lose credit for payments toward loan forgiveness: One of the most important things to consider before consolidating student loans is that if you are currently paying your loans using an income-driven repayment plan or have already made qualifying payments toward PSLF, consolidating your loans will result in the loss of credit for payments already made toward loan forgiveness. However, there is now a one-time income-driven repayment account adjustment that allows borrowers to not lose credit from past payments if they choose to consolidate their loans.

How to Apply for a Federal Direct Consolidation Loan

The Direct Consolidation Loan application process is available through StudentLoans.gov and comes with no fees. You simply fill out the online application or you can print out a paper version and mail it. The entire online application process takes less than 30 minutes, on average.

Almost all federal student loans are eligible for consolidation. If you have private education loans, you cannot consolidate them with your federal loans. Also note that you can’t consolidate your loans while in school and must graduate, leave school, or drop below half-time enrollment in order to pursue consolidation. Parent PLUS Loans cannot be consolidated with loans in the student’s name.

You can also select which loans you do and do not want to consolidate on your loan application. For instance, if you have a loan that will be paid off in a short amount of time, you might consider leaving it out of the consolidation.

Remember to keep making payments on your loans during the application process until you are notified that they have been paid off by your new Direct Consolidation Loan. Your first new payment will be due within 60 days of when your Direct Consolidation Loan is paid out.

Repayment Plans for Consolidation Loans

A Direct Consolidation Loan will have a fixed interest rate that is the weighted average of all of the interest rates for the loans you are consolidating, rounded up to the nearest one-eighth of a percent. This means that the interest rate on your largest loan will have the most impact on your consolidation interest rate, whether that interest rate is high or low.

When you apply for a Direct Consolidation Loan, you must also be prepared to select a repayment plan. Many repayment plans are available for Direct Consolidation Loans, including:

•   Standard Repayment Plan

•   Graduated Repayment Plan

•   Extended Repayment Plan

•   Revised Pay As You Earn Repayment Plan (REPAYE)

•   Pay As You Earn Repayment Plan (PAYE)

•   Income-Based Repayment Plan (IBR)

•   Income-Contingent Repayment Plan (ICR)

Recommended: What Student Loan Repayment Plan Should You Choose? Take the Quiz

Consolidation for Defaulted Student Loans

Consolidation can also help student loans that are currently in default. Student loans will go into default after 270 days without payment, which can result in consequences and loss of benefits, such as damaging your credit score or possible wage garnishment.

Since loans in default are accelerated and the entire unpaid balance becomes due when you enter default, consolidation is worth considering since it allows you to pay off one or more federal student loans with the new Direct Consolidation Loan.

Once your consolidated loan is out of default, you can repay the Direct Consolidation Loan under an income-driven repayment plan or make three consecutive payments. Direct Consolidation Loans are eligible for benefits such as student loan deferment, forbearance, and loan forgiveness.

Refinancing vs Consolidation for Student Loans

For those interested in a better interest rate or more favorable loan terms, you could consider refinancing your student loans instead of consolidating them. Unlike consolidation, refinancing can combine both federal student loans and private student loans into one new loan with one monthly payment.

Keep in mind that refinancing can result in the loss of federal benefits since you’re working with a private company and not the government. If you plan on using income-driven repayment plans or student loan forgiveness, for example, it is not recommended to refinance with a private lender. However, for someone looking for lower interest rates or lower monthly payments, refinancing is an option to consider.

The Takeaway

A Direct Consolidation Loan combines your federal loans into one new loan with one monthly payment. Pros may include lowering your monthly payments, allowing you to switch from a variable to a fixed interest rate, and making certain loans eligible for forgiveness. The major con of Direct Consolidation Loans is possibly paying more in interest over the life of the loan due to the extension of your loan term.

If the idea of consolidation appeals to you but the weighted consolidation interest rate won’t save you much over the life of your loan, you could consider applying for student loan refinancing with SoFi. SoFi offers an easy online application, competitive rates, and flexible terms. But remember, refinancing makes it so you’re no longer eligible for federal benefits.

See if you prequalify with SoFi in just two minutes.

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SoFi Student Loan Refinance
If you are a federal student loan borrower, you should consider all of your repayment opportunities including the opportunity to refinance your student loan debt at a lower APR or to extend your term to achieve a lower monthly payment. Please note that once you refinance federal student loans you will no longer be eligible for current or future flexible payment options available to federal loan borrowers, including but not limited to income-based repayment plans or extended repayment plans.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Unicorns are private companies with valuations of $1 billion or more. The term was coined by venture capitalist Aileen Lee in her 2013 piece “Welcome to the Unicorn Club: Learning From Billion-Dollar Startups.” She used the word “unicorn” in order to convey the rarity of startups that hit the $1 billion mark.

When Lee came up with the term, she counted 39 unicorns in the U.S. It was still considered exceptional for a private company to grow to that size without having an initial public offering or IPO. These days, a combination of trends — companies staying private longer, widespread technological changes, and abundant money in capital markets — has enabled the creation of numerous unicorns.

Top 10 Most Valuable Unicorns

As of July 2023, there are over 1,200 unicorns worldwide, with a cumulative business valuation of $ $3.84 trillion, according to research by CB Insights, a business analytics platform.

Unicorns can be exciting for investors because they can represent rapid — even seemingly magical — growth. But are unicorns actually good investments? It’s important for investors to remember that these companies haven’t yet come under the scrutiny of public markets.

Below is a chart of the unicorn companies with the highest valuations, according to CB Insights, as of May 2023.

Company	Valuation	Date Added	Country	Industry
Bytedance	$225 billion	4/7/2017	China	A.I.
SpaceX	$137 billion	12/1/2012	U.S.	Space
SHEIN	$66 billion	7/3/2018	China	eCommerce
Stripe	$50 billion	1/23/2014	U.S.	Fintech
Canva	$40 billion	1/8/2018	Australia	Internet software & svcs.
Revolut	$33 billion	4/26/2018	U.K.	Fintech
EpicGames	$31.5 billion	10/26/2018	U.S.	Other
Databricks	$31 billion	2/5/2019	U.S.	Data management
Fanatics	$31 billion	6/6/2012	U.S.	eCommerce

Source: CB Insights

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

Characteristics of Unicorn Companies

The rapid increase in the number of unicorns has meant that these companies come from a range of industries or sectors, and geographics. Answers to questions like ‘How old are these companies?’ and ‘Who are the founders?’ have also started to vary. Let’s look at some broad-stroke trends.

Unicorns by Industry

According to Embroker, an insurance brokerage, the bulk of unicorns come from seven sectors: e-commerce, fintech, internet software, AI, healthcare, travel technology, and education technology.

Unicorns by Geography

While the Bay Area’s Silicon Valley is still synonymous with startups, a greater number of unicorn businesses have sprung from elsewhere.

Cities Home to Most Unicorns, as of May 2023

City	Number of Unicorns
San Francisco	64
Beijing	51
New York	34
Shanghai	27
London	15
Hangzhou	13
Shenzhen	13
Boston	10

Source: Statista, CB Insights

Other Traits of Unicorns

Lately, U.S. unicorns have tended to be older when they enter the stock market. When Aileen Lee coined the term in 2013, the median age of a tech IPO company was nine years, data from University of Florida shows. Going back further in time, during the height of the dot-com bubble in 1999, the median age was four years. Fast forward to 2023, and the median age has jumped to 12.5 years.

When it comes to profitable businesses, though, the number has dwindled. According to Statista’s most current research, as of June 30, 2022: “The share of companies in the United States which were profitable after their IPO has been decreasing year-on-year over the past decade from a peak of 81% in 2009. In 2021, only 28 percent of companies were profitable after their IPO.”

When it comes to who’s founding these unicorns, there has been some increase in diversity. Back in 2012 or 2013, when Aileen Lee did her initial IPO research, no unicorns had female founding CEOs. However, by 2019, 21 startups founded or co-founded by a woman became unicorns.

Why Are There So Many Unicorns?

There are several reasons behind the proliferation of unicorn companies. Here are a couple.

1.    Expansion of Private Markets: As mentioned above, companies are waiting longer before they go public. Part of the reason for that has been that private investments have exploded. Startups can continue to get investments from venture-capital firms (VCs) and private-equity funds in their later stages, and some prefer that option over the risky, complex process of having an IPO.

2.    Sweeping Technological Change: Significant innovations — such as the rise of social media, smartphones and cloud computing — fueled growth in many unicorns. For example, the iPhone debuted in 2007, while the first Android hit the market in 2008. These events led to businesses that operate mobile apps or capitalize on smartphones to drive up sales.

3.    Well-Funded Capital Markets: Since the 2008-2009 financial crisis, growth in the economy has been sluggish. That’s meant central banks worldwide have kept monetary policies easy, injecting capital into markets that have found their way into fledgling companies.

Meanwhile, tech investing has been one of the few bright spots for investors hungry for growth opportunities, driving up startup valuations.

How Do Unicorns Get Valued?

Many startups — even ones of unicorn size — are unprofitable. Investors put in money under the assumption that profits will eventually come, and that’s why businesses may rely on longer-term forecasting. Similar to how it works when it comes to growth vs. value stocks, valuation metrics like price-to-sales ratios may be used in order to measure the company’s worth.

Investors may also come up with valuations by comparing unlisted firms with similar businesses that are publicly traded. Hence, a rising stock market may also lead to higher valuations for privately held companies.

However, an academic study updated in January 2020 concluded that out of 135 venture-backed unicorns, 48% were overvalued on average, with 14 being 100% above fair value. That means around half of these supposed unicorns aren’t actually unicorns.

How to Invest in Unicorns

Accredited investors — those with $200,000 in annual income or $1 million in assets — can get exposure to unicorns by putting money into venture-capital funds: capital pools that invest in private companies. In recent years, because of the soaring success of some unicorns, they’ve attracted not just venture-capitalists, but also hedge funds, asset-management firms like mutual funds as well as sovereign wealth funds.

When it comes to exiting unicorn investments, a Crunchbase article pointed out that the majority of unicorns — two-thirds over a five-year period — conducted an IPO, giving their investors the opportunity to cash out. But in 2020, the majority of unicorn exits have been through acquisitions.

Can Average Investors Invest in Unicorns?

Unicorns don’t generally accept modest investments from individual or retail investors.

Jay Clayton, former chairman of the Securities and Exchange Commission, argued that smaller investors should get access to private-market investments. The fact that companies are staying private for longer has also made it true that individual investors are missing out more on businesses in their early stages.

But skeptics say private markets don’t have the same disclosure requirements that public markets require, a situation that could leave retail investors in the dark about a company’s financials and increase the risk of fraud. Mutual funds can put up to 15% of assets in illiquid assets, but often they don’t allocate that much to private companies since these investments are tougher to sell.

Deep-pocketed retail investors can get in early with some startups via angel investing — when individuals provide funding to very young businesses. But these businesses tend to have valuations nowhere near $1 billion.

💡 Quick Tip: Newbie investors may be tempted to buy into the market based on recent news headlines or other types of hype. That’s rarely a good idea. Making good choices shouldn’t stem from strong emotions, but a solid investment strategy.

Risks of Investing in Unicorns

Not all unicorns successfully transition into stock market stars. Some see their valuations dip in late private funding rounds. Some have even scrapped IPO plans at the last minute. Others disappoint after their debut in the public markets, finding that first-day pop in trading elusive or underperforming in the weeks after the IPO.

How do you know whether a unicorn is destined to be the next market darling or flame-out? There is no way to know for sure, but there are a number of risks when it comes to unicorn investing. Here are some:

•   Lack of Profitability: Many unicorns offer deeply discounted services in order to supercharge growth. While venture capitals are used to subsidizing startups, public market investors may be tougher on unprofitable businesses.

•   Market Competition: No matter how great an idea is and how much funding they bring in, there are always competitors. If another company has superior marketing, more users and higher sales, this may not bode well for a unicorn.

•   Consumer/Business Need: Just because a founder has a cool idea and they can build it, doesn’t mean anybody will spend money on it.

•   Management Team: Who are the company’s founders, and what is the culture they are creating at their startup? Many startups fail, and a founder’s management style and lack of experience can be cited as major reasons why.

•   Regulatory Changes: Some unicorns represent new business models or disrupt existing industries. Such changes may come with regulatory oversight that makes operating difficult.

Alternative to Unicorns in Startup Terminology

The surge in private-market tech investing has led to a new vernacular that’s specific to startup valuations. Here’s a table that covers some popular lingo.

List of Unicorn Terminology

Startup Term	Definition
Pony	Company worth less than $100 million
Racehorse	Company that became unicorns very quickly
Unitortoise	Company that took a long time to become a unicorn
Narwhal	Canadian company with a valuation of at least $1 billion
Minotaur	Company that has raised $1 billion or more in funding
Undercorn	Company that reached a $1 billion valuation then fell below it
Decacorn	Company with a valuation of at least $10 billion
Hectocorn	Company with a valuation of at least $100 billion
Dragon	Company that returns an entire fund, meaning the single investment paid off as much as a diversified portfolio

The Takeaway

While they started out as rarities, unicorns have since multiplied. And now a herd founded over the past decade is headed for the stock market.

For investors, unicorn companies may appear to be a good way to diversify and get access to a high-growth business. But it’s important to remember that many unicorns are unprofitable businesses that secure $1 billion valuations by making very long-term projections. Plus, financial information isn’t as readily available as for a company that’s already listed.

It’s important to look closely at a new company’s management team, history, as well as financials before investing in it. Whether you’re a new or seasoned investor, researching which stocks to buy and when to buy them can be time-consuming and challenging.

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