If you’re in the market to purchase a new home, perhaps because mortgage rates are low and the “worst is behind us,” you may be thinking low down payment all the way.
Heck, for many borrowers, a low down payment is the only way to play.
In case you hadn’t heard, zero down mortgages are essentially extinct, but there are still other low-down payment options, such as the ever popular FHA loan, which only requires 3.5% down, along with other conventional mortgage options.
And while an FHA loan and other low-down payment mortgages can make homeownership more accessible, your mortgage payment will rise, which obviously hits your affordability.
[See: Debt-to-income ratio.]
Larger Mortgage Amount
- The most obvious downside to a lower down payment
- Is a larger loan amount
- Since the less you put down, the more you’ll need to pay off
- Pay extra attention to loan amount if it’s close to the conforming limit
First and foremost, if you put less money down, you’ll wind up with a larger mortgage. There’s really no way around it.
And a larger mortgage balance means a larger monthly mortgage payment. So the less you put down upfront, the more you pay each month.
That larger mortgage balance also means you’ll pay more in interest over the life of the loan. So this hurts two-fold.
Higher Interest Rate
- Another issue with putting less down
- Is a potentially higher interest rate
- Lenders charge pricing adjustments for high-LTV home loans
- This could increase your mortgage rate a little or a lot depending on all the factors in play
That low down payment will also mean a higher loan-to-value ratio, which will generally lead to a higher interest rate on your mortgage.
So if you decide not to put 20% down, and instead opt for 5% or less, you’ll probably be stuck with a higher mortgage rate.
And as we all know, a higher interest rate means a higher mortgage payment, and more money paid out in interest.
This can add up significantly over the life of the loan as well.
It could also affect outright eligibility. In other words, you may need to put down more to even get approved for a mortgage to begin with.
- One final problem with low-down payment mortgages
- Is the mortgage insurance requirement
- Which applies to most loans where the down payment is less than 20%
- This can greatly increase your overall housing payment as well
This insurance, which protects lenders from the higher risk of default associated with a low-down payment mortgage, will be added on top of your monthly mortgage payment.
So you’ll owe even more each month, that is, until you pay your loan down to 80% LTV and ask that the insurance be removed.
Also keep in mind that the FHA just raised mortgage insurance premiums, so it’s not as cheap as it used to be.
Let’s look at an example to put it all in perspective:
Purchase price: $400,000
20% down: $80,000
$320,000 loan amount @3.75%
Monthly mortgage payment: $1481.97
Total interest paid: $213,509.20
5% down: $20,000
$380,000 loan amount @4.375%
Monthly mortgage payment: $1897.28
Total interest paid: $303,020.80
So assuming you went with a 30-year fixed mortgage, the 5% down option would result in a monthly mortgage payment more than $400 higher than the 20% down option (before mortgage insurance is even factored in).
And you’d pay nearly $90,000 more in interest over the life of the loan.
In other words, down payment matters. A lot.
Bonus: The amount you put down can also keep your loan out of the jumbo mortgage realm, which will make it even cheaper. So consider that as well if you happen to be close to the conforming loan limit.
As always, be sure to do plenty of homework and mortgage rate shopping. If you take the time to consider all scenarios, you may be able to get the best of both worlds, a low-down payment mortgage with a low interest rate.
Learn more by reading my primer on mortgage down payments.