Why You Should Consider a Down Payment

If you are thinking of buying a home, there are several low down payment mortgage options that you can consider. As the real estate market continues to recover, even more low down payment options are being introduced by lenders.

Here are some options that exist:

• 0% down – VA and USDA Loans
• 3.5% down – FHA Loans
• 5% down – Conforming loans to $417,000
• 10% down – High Balance Conforming loans to $625,500
• 10% down – 80/10/10 loan to $1 million
• 15% down – 80/5/15 loan to $1.5 million

While these low down payment options can help you to buy a bigger house, they can also be expensive in the long run.

Let’s look at the impact:

Higher Interest Rate – A low down payment is a higher risk for lenders. The industry follows risk-based pricing – the higher the risk, the higher the rate/fees. FHA, VA and USDA apply either an upfront funding fee or mortgage insurance, or a combination of both. Fannie Mae and Freddie Mac, the two agencies that back up all conforming loans, charge a higher interest rate and/or fees when you have less than a 25% down payment. Depending on your credit score and some other parameters, rates can be .125% to .25% higher for someone putting down 10% versus 25%.

Private Mortgage Insurance (PMI) – All conforming loans carry a PMI to cover their risk if you put down less than 20%. Depending on your loan amount and credit score, you may end up paying a monthly insurance of less than $100 to over $300. In some cases, you will be able to get rid of this payment when you gain enough equity where your loan balance is 80% of the original purchase price.

But, FHA loans recently changed the guidelines to require you to pay PMI for life of the loan if you put down less than 10%. The only way out is to refinance into a conforming loan.

High Variable Rate Loan – On high balance or Jumbo loans, to avoid the PMI, you can split the loan into two mortgages via a loan program called 80/10/10 loan, or a piggyback mortgage. Such loans carry high interest second mortgages, which are tied to the Prime rate and are variable from the get go. Besides carrying the risk of an adjustable rate, they are also typically more expensive than the current market rate. One of the most popular second mortgages currently has a 5.24% rate, about 1% higher than the average 30-Year Fixed rate.

Considered less favorable by sellers – In a seller’s market like the San Francisco Bay Area, where demand far outstrips supply and multiple offers are not uncommon, sellers shy away from offers with a low down payment. They believe someone with a higher down payment will have their loan approved much faster and hence is a better bet.

All these reasons in no way mean that you should wait until you have a 20% or higher down payment before buying a house. But, you should consider the higher cost of low down payment before making a decision regarding home ownership.