Buying a house is overwhelming.
You need to prepare your credit for a home purchase.
You need to save for a down payment, closing costs and future maintenance expenses.
Even after you have all of that done, you need to figure out what type of mortgage to take out.
Many people consider FHA mortgages due to the low down payment requirement, while others suggest putting 20 percent down.
Is a small down payment on your mortgage a big deal?
An Example of a Small Down Payment Mortgage – FHA Loans
When you don’t have a large down payment of at least 20 percent and you’re trying to buy a house, FHA loans are one popular option. Why? They only require a 3.5 percent down payment.
Unfortunately, these mortgages aren’t all good. In fact, you’ll end up paying quite a bit in fees. Now more than ever, you really do pay for having such a small down payment. We aren’t talking just a few bucks.
We’re talking thousands of dollars.
Due to putting down such a low amount of money, you must pay mortgage insurance premiums. What’s worse is this fee won’t be paid just once.
Up Front Mortgage Insurance
When you take out an FHA loan, you’ll have to pay an up front mortgage insurance premium (UFMIP) of 1.75 percent. Since you likely don’t have the money to pay this up front, it may be incorporated into your loan amount.
This means, in addition to paying a UFMIP of 1.75 percent, you’ll be paying interest on this up front premium over the life of the loan.
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 30 year mortgage.
Thankfully, there is a way to avoid this pointless fee, but first there is some more bad news.
Annual Mortgage Insurance For The Life Of Your Loan
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. However, things get much, much worse with the new FHA rules that took affect in 2013.
Prior to 2013, 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 percent. That changed.
From April 2013 forward, the annual mortgage premium insurance can no longer be cancelled when your loan to value ratio goes below 78 percent. You have to pay it for the entire length of the loan.
You can’t ever cancel it. Total bummer for anyone who thought a FHA loan was a viable option.
If that wasn’t bad enough, the FHA annual mortgage insurance premiums is 0.85 percent every single year if your loan to value ratio is greater than 95 percent. It drops to 0.80 percent annually if your loan to value ratio is less than 95 percent.
Rates are even higher for large mortgages.
These fees are insane when you realize they will be charged for every year of a 30 year mortgage.
So, what is the secret you can follow to save thousands of dollars over the life of your mortgage?
It’s pretty simple.
Have A Proper Down Payment
It seems so simple to have a proper down payment of at least 20 percent 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, and many years in most cases, in order to reach that 20 percent down payment. Even though it takes years, it is worth it.
By putting a 20 percent down payment on your new house you won’t have to pay the up front mortgage insurance premium of 1.75 percent. You won’t have to pay the annual mortgage insurance premium of 0.80 to 0.85 percent, either.
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 said, 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 percent?
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 percent down on a house 5 or 10 years from now.
Unfortunately, crystal balls don’t exist and time machines haven’t been invented yet. You’ll have to make that decision for yourself. I’m just presenting the options as I seem them today.