Low down payment mortgages are coming back around as the housing market improves. Buyers can, once again, get a mortgage with as little as 3.5 percent down, especially on a Federal Housing Administration mortgage. (Some government programs even offer 0 percent down mortgages)
Mortgages that don’t require the traditional 20 percent down can be great. After all, it can take a very long time to save up a 20 percent down payment. And for people struggling to save money after paying rent each month, putting 20 percent down is virtually impossible.
So the availability of these lower down payment mortgages is a good thing for many potential homebuyers. But before you jump into a mortgage with a very low down payment, be sure you understand exactly what that mortgage will cost you.
Higher Interest Rate
Depending on your lender and your financial history (especially your credit score), a lower down payment may mean a higher interest rate. Even a half percentage increase in your interest rate can make a big difference.
For instance, on a $200,000 30-year fixed-rate mortgage, your payments would be $1,330.60 per month if your interest rate was 7 percent. Over the life of your loan, you’d pay $279,017.80 in interest, according to Bankrate’s amortization calculator.
At 7.5 percent interest on that same loan, your monthly payments would be $1,398.43, and you’d pay a total of $303,434.45 in interest. That 0.5 percent makes a difference of nearly $25,000 over 30 years!
Now, to find out how a low down payment could affect your interest rate, talk to a few lenders. Ask for a rate estimate with your current down payment, and then ask how a higher down payment could affect your interest rate.
Private Mortgage Insurance
Any time you put less than 20 percent down on your home (except with some specialized loan programs), you’ll have to pay what’s called private mortgage insurance. This insurance goes to a third party and basically guarantees the lender that if you default on your loan, the lender will get their money back out of the investment.
Private mortgage insurance is calculated as a percentage of your loan, ranging usually from 0.3 percent to 1.15 percent. This could cost you anywhere from $50 a month to more than $100 and will be added to your mortgage payments.
It used to be that with nearly all loans, you could cancel PMI once your loan-to-value ratio dropped below 80 percent – in other words, when you made enough payments to build up 20 percent equity in your home.
This is still true with many low down payment mortgages. However, the Federal Housing Administration, the purveyor of the most popular and accessible low down payment options, recently started requiring borrowers to pay PMI for the entire life of their mortgage.
Now, you can still get out of paying PMI on an FHA loan. You’ll just have to refinance to do it, and it’s just more of a hassle.
PMI payments may not seem like much, but if you have to make them for five or 10 years until you have 20 percent equity, these payments can add thousands of dollars to your total loan costs.
Higher Monthly Payments
If you want to buy a $200,000 home, how much of a difference can a bigger down payment make? A lot.
If you put 5 percent down on a 30-year, fixed-rate 7 percent interest mortgage for a $200,000 home, your monthly payments will be about $1,264. Bump up your down payment to 10 percent, and you’ll pay more like $1,197.65. Take your down payment all the way up to 20 percent, and your monthly payments will be just $1,064 per month.
Add in the money for PMI payments on a low down payment mortgage, plus a potentially higher interest rate, and you’ll see that your monthly payments could be hundreds of dollars higher than with a 20 percent down payment mortgage.
For some people, a low down payment mortgage is the best option – especially if you live in an area where homeownership is truly cheaper than renting. But before you jump into a mortgage putting less than 20 percent down, calculate the real costs of such a decision. Then, and only then, should you move forward with a low down payment mortgage.