The down payment is the biggest impediment to buying a home according to surveys, but in reality many individuals can qualify for a mortgage with as little as 3 percent down.
It is important to compare loans and do the math. Consider your closing costs (the cash you need in-hand), the monthly mortgage payment, and if that payment will go down or up in a few years. Paying a few more dollars each month in the beginning can sometimes save borrowers money in the long term.
For this exercise, we compare a $234,900 home purchase (the national median home price as of December 2016), with a 5 percent down payment and a 720 FICO score. And because calculators and loan terms vary, consider these costs as examples only. A mortgage professional can provide you with specific estimates.
Conventional loan with PMI
A conventional loan is a traditional mortgage from a lender that is not insured by a government agency. With a 5 percent down payment, the borrower finances the remaining 95 percent over 30 years with a 4 percent interest rate. Private mortgage insurance (PMI) is required because of the low down payment and is $78 of the monthly bill, making the total monthly mortgage payment $1,143.
Pros: A borrower can get a conventional loan with PMI with as little as 3 percent down. PMI can be cancelled once 20 percent equity in the home value is reached, which means your monthly bill decreases.
Cons: For some borrowers, a 5 percent versus 3 percent down payment may be a better deal as costs may be lower. However, for many prospective homebuyers looking to lock in low interest rates, build equity and home appreciation faster, an option to get into a home with the lower down payment may be better.
A combo loan (aka piggyback mortgage)
A piggyback involves two separate loans simultaneously. In this scenario, the first "primary" mortgage covers 80 percent of the loan with a 30-year fixed interest rate of 4 percent; the second loan is for 15 percent with 10-year fixed interest rate of 5 percent; and the remaining 5 percent is the down payment. The total monthly mortgage payment would be $1,271.
Pros: The borrower will not pay PMI.
Cons: It may be a more expensive as the borrower will pay closing costs on two loans. And unlike PMI, the piggyback loan doesn't cancel, but will be paid off over the term of the mortgage. The second loan often comes with higher interest rates too.
FHA loans are mortgages insured by the government through the Federal Housing Administration. The limits for FHA loans typically are lower than conventional mortgages. However, FHA mortgage insurance cannot be cancelled and must be paid for the life of the loan. FHA has other specific requirements, like the condition of the home. In this scenario, the mortgage is set at 95 percent of the home's value with a 30 year fixed interest rate of 3.75 percent. The total monthly mortgage payment would be $1,199.08.
Pros: A borrower can get a FHA loan with as little as 3.5 percent down and a FICO score as low as 600 may qualify.
Cons: FHA mortgage insurance cannot be canceled, so your monthly bill won't be reduced the way it is with a conventional loan with PMI. Also, FHA loans are subject to an upfront fee of 1.75 percent that is financed over the life of the loan.
No matter what you choose, do the math and compare so you can make an informed decision. If the conventional option sounds appealing, LowDownPaymentFacts.com provides more information.