Buying a Home: Is a Small Down Payment Actually a Big Deal?

new 2013 fha loan feesOn Wednesday we went over why it is important to know your credit report info and credit score at least a year ahead of when you’re planning to purchase a house. Today is the second part of things you should do at least a year in advance of buying a house and we’ll be discussing whether or not a small down payment is actually a big deal or not.

An Example of a Small Down Payment Mortgage – FHA Loans

When you don’t have a large down payment of at least 20% and you’re trying to buy a house, FHA loans are one option that has been popular in the last few years due to the low minimum down payment of 3.5%. Unfortunately, these mortgages have a ton of fees and they’ve recently drastically increased. Now more than ever, you really do pay for having such a small down payment and weren’t not talking just a few bucks. We’re talking thousands of dollars.

Due to putting down such a low amount of money, you will be required to pay mortgage insurance premiums and it won’t be just once. When you take out the loan you’ll have to pay an  up front mortgage insurance premium (UFMIP) of 1.75%. Since you likely don’t have the money to pay this up front, they will incorporate it into your mortgage loan amount.

This means, in addition to paying a UFMIP of 1.75%, you’ll be paying interest on this up front premium over the life of the loan which could be as long as 30 years. On a $200,000 mortgage this fee would end up being $3,500 before you pay any interest on the premium you rolled into your mortgage over the 30 year life of your loan. There is a way to avoid this pointless fee… but first there is some more bad news.

If that was the only fee, it wouldn’t be the end of the world. You’d just be paying a few thousand more than you should. I wish you could see my eyes rolling… However, things get much, much worse with the new FHA rules that have taken affect in April 2013. In the past, you’ve always had to pay annual mortgage premium insurance until your loan to value ratio (how much principal you owe on your loan versus the value of the house) decreases below 78%. That is changing.

From April 2013 forward the annual mortgage premium insurance will no longer be cancelled when your loan to value ratio goes below 78%. You have to pay it for the entire length of the loan. It won’t ever be cancelled. Total bummer for anyone who thought a FHA loan was a viable option.

If that wasn’t bad enough, the FHA annual MIP is increasing to 1.35% every single year if your loan to value ratio is greater than 95% and 1.30% annually if your loan to value ratio is less than 95%. Talk about crazy additional fees for the next 30 years of your 30 year mortgage!

So what is this second secret that you can follow to save thousands and thousands of dollars over the life of your mortgage? It’s pretty simple.

Have a Proper Down Payment

new 2013 fha mortgage feesIt seems so simple to have a proper down payment of at least 20% when you buy a house but it isn’t an easy feat to accomplish. That’s why you need to start saving at least a year in advance in order to reach that 20% down payment. For many people it’ll take many years to save that down payment but it is worth it. By putting a 20% down payment on your new house you won’t have to pay the up front mortgage insurance premium of 1.75% or the annual mortgage insurance premium of 1.35% (or if you’re lucky and put 5% down, 1.30%).

Yes, it takes a while to come up with a proper down payment. No, it isn’t fun sacrificing to be able to save the money. That sacrifice could easily save you tens of thousands of dollars over the life of your mortgage.

Which is more important to you? Having a house today and paying thousands of dollars extra for it? Or waiting and putting down 20%?

P.S. Yes, I know it isn’t that simple. Times change, house prices can increase and mortgage rates can do the same. You might end up better off in the future if you get an FHA loan today than if you put 20% down on a house 5 or 10 years from now. Unfortunately, no one has a crystal ball and time machines haven’t been invented yet so you’ll have to make that decision for yourself. I’m just presenting the options as I seem them today.

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About Lance Cothern

Lance Cothern, a Certified Public Accountant (CPA) licensed in the Commonwealth of Virginia, is the founder of Money Manifesto. You can read more about him here or connect with him on Facebook, Twitter, Google+ or Pinterest.


  1. I’ve always been conservative in the belief that if you don’t have 20% to put down, then you aren’t yet able to afford buying a house. I’ve bought two homes in my life and have put 20% down on both. I know many will argue and will disagree with my viewpoint, but in my mind I’ll always reconcile my opinion with the fact that for decades, 20% was almost a requirement, and the housing market never had a crash and never had a long period of declining values, and foreclosures were few and far between.

  2. We didn’t put any money down as we bought our house with a VA loan (which doesn’t require any money down). There are about three million reasons that people give regarding why military families shouldn’t buy houses because we are so transient but it was the right decision for us at the time. I guess I’ll let you know in 4-5 years if it was a good decision or not! 😉 However, when we are buying our “forever home”, I would certainly like to put a significant down payment.

  3. I hadn’t heard about those changes in FHA loans. There goes that option! Looks like we will be saving up a $80,000-100,000 down payment the first time around. 🙁

  4. Although I am in favor of a sizable (20%) down payment, I think it is more important to make sure the mortgage payment and all the associated expenses (property taxes, insurance & maintenance) are affordable.

  5. I noticed this change as well. While we can save up the proper down payment, it is going to take a while. We have PMI on our current home and it isn’t too bad. That was before the bubble burst though. We didn’t put anything down. I want to put money down on our next home, but 20% is very high and makes home ownership out of reach for many. I would rather have a payment that I can easily afford, then drop thousands upfront and not have much afterwards. You can’t just think of the down payment, you have to think about having fluid funds available afterwards.

  6. I feel like every person I meet that touts having or the need to have 20% down has rich parents or grandparents who “loaned” them the money. To these people, give proper credit where it’s due: you wouldn’t be able to afford a home, much less save 3.5% for a FHA loan, if it weren’t for your generous parents/grandparents. I know because I see how you spend. On the other hand, I don’t come from wealth, but I have good credit and stable employment. If I waited until I saved 20% down on my income, I’d be too old or wasting years paying someone else’s mortgage by renting. I bought a home a few years ago and am a FHA loan holder. Sure, I’d rather not pay MIP/PMI, but everyday I’m in my house, I know I wouldn’t be here if I didn’t get this loan. My mortgage is affordable and I love being a homeowner. I think FHA is a great program. It certainly helped me.

    • Tammy,

      I definitely understand where you’re coming from. FHA loans have their place, but the new fees that come with FHA loans substantially increase the cost of the mortgage more than previous FHA loans. People should at least be aware of the new rules :).

      As far as having 20% down, I’ve bought two houses, a smaller townhouse that was very very affordable, and our first single family home. On both I’ve had 20% down and haven’t been gifted a penny. I’m lucky to have a well paying job for my area and live in an area with a lower cost of living, but it is possible. It just takes a lot of disciple, a lot of saving, and some sacrifice in other areas of your monetary life.

      • Lance, it’s also nice that your patents helped you pay for your education (as stated in your bio). This means you were able to save more and faster because you didn’t have any school debt. Not everyone is as fortunate.

        • *parents (although you’re smart so I wouldn’t be surprised if you had a few patents too 🙂

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