As you save for a down payment (you’re totally taking advantage of these saving tips, right?) and get closer to house hunting time, you’re going to find yourself facing some big decisions about the type of home loans available to you.
That’s why researching loan types early on is smart. Why? Because while some loans require a hefty 20 percent down payment, others come with a cool 0 percent down. Sure, there are pros and cons to each, but let’s be real: If you’re putting no money down, you’re obviously going to be paying more out of pocket each month. But for a lot of people, that may be easier than coming up with a big chunk of cash.
The trick is to understand each loan type and how it affects your down payment and monthly mortgage payment. Let’s dig in!
Understanding Down Payments
First, let’s clarify exactly what a down payment is.
A down payment exists to offset the risk that your lender takes on. The less money they have to loan you for a house, the less they lose in the event of a foreclosure. The down payment is applied to the purchase price of the home, and the lender loans you the balance. For example, if you put $90,000 down on a $300,000 home, your mortgage would be for $210,000.
First-time homebuyers often assume they have to have a 20 percent down payment to buy a house. While the full 20 percent will get you a more favorable loan, it’s not required. The catch is that when a lender has to take on a bigger risk, you often have to pay for mortgage insurance that protects the lender in the event that you default on the loan (foreclosure, short sale, etc.).
Understanding Mortgage Insurance
You’ll see a few different types of mortgage insurance on home loans. Again, mortgage insurance exists to protect the lender if you stop paying your mortgage.
PMI usually costs between 0.5 percent and 1 percent annually of the total loan. It is paid monthly, just as any other mortgage premium. For convenience, it is added to your monthly mortgage payment, and the exact amount is disclosed to you on your loan closing statement. For example, for PMI on a $300,000 loan, expect to pay as much as $250 extra per month to your mortgage.
Up-Front Mortgage Insurance Premium
UFMIPis equal to 1.75 percent of the total loan and is due at closing. You can pay it in addition to your closing costs or roll it into your loan and pay on it monthly. For example, UFMIP on a $300,000 loan would be $5,250 due at closing or divided into your monthly mortgage payments. Keep in mind that you’ll be paying interest on any costs you roll into your mortgage. So you’ll end up paying more like $9,000 on that $5,250 over the course of a 30-year loan, but it will only tack on about $25 per month. So if that’s an easier pill to swallow than the full amount up front, then that’s the right decision for you.
Like PMI, annual MIP is calculated annually but paid monthly, and is 0.45 percent to 1.05 percent of the total loan. For example, for annual MIP on a $300,000 loan, expect to pay as much as $260 extra per month to your mortgage.
Different loan types might have one, or even a combination, of mortgage insurance requirements. It’s important to understand each and exactly how they’ll affect your down payment and monthly mortgage payment.
Understanding Loan Types
A conventional loan generally requires a 20 percent down payment, which makes it the most favorable type of loan. Interest rates vary based on the current market, your credit rating and whether you have the desire and ability to buy down the rate. What does that mean? Mortgage points, or discount points, are fees you pay to your lender at closing in exchange for a reduced interest rate — hence, “buying down the rate.” When interest rates are high and you’re looking at a 30-year loan, the ability to buy down the rate can save you thousands over the course of the loan.
The benefit of a conventional loan is that there is no mortgage insurance if you put down 20 percent or more. If you qualify for a conventional loan but put less than 20 percent down, you will have to pay monthly PMI.
An FHA loan is backed by the Federal Housing Administration. It requires a 3.5 percent to 10 percent down payment, depending on your credit score. Like a conventional loan, the interest varies based on the market and your credit score, and you still have the ability to buy down the rate.
While the lower down payment can help first-time homebuyers and lower income buyers, the catch is that you have to pay two types of mortgage insurance with an FHA loan: UFMIP and annual MIP.
These loans are backed by the U.S. Department of Agriculture. They allow moderate to low-income borrowers to purchase a home with 0 percent down on homes within a USDA eligibility area. Typically referred to as a “rural” area, the eligibility area actually covers around 97 percent of the United States and even includes a number of suburban areas outside of major cities. Mortgage insurance is typically required for a USDA loan, but the rates are just 0.30 percent for annual MIP and 1 percent for UFMIP. USDA borrowers can also finance 100 percent of their closing costs.
The catch? You cannot make more than 115 percent of your eligibility area’s median income. Meaning, if the median income in your area is $80,000, you cannot make more than $92,000 to qualify for a USDA loan.
VA loans are a valuable benefit to veterans and active service members of the U.S. armed forces. These loans are backed by the U.S. Department of Veteran Affairs. Like other types of loans, the interest rates vary and are based on a variety of factors, including market conditions, credit score and your ability to buy down the rate.
The biggest advantage of a VA loan is that it requires 0 percent down and does not have mortgage insurance.
Before applying for a loan from a lender, veterans and service members must apply for a certificate of eligibility. Aside from this minor administrative task, a VA loan is an incredibly favorable loan if you qualify.
Hopefully this gives you a good starting point as you begin to research loans. What you qualify for can have a major impact on your down payment and monthly mortgage payments, so it’s smart to start researching early so you know how much house you can afford. And remember, your lender should be a source of help. Don’t hesitate to have them “run the numbers” on multiple loan types and loan amounts. Buying a house is the biggest investment most people make in life, so it makes sense to want to see several scenarios and how they will truly affect your wallet.
Liyya Hassanali is a Project Manager and Content Strategist for Kinship Design Marketing, a boutique agency that provides marketing strategies and content for architects, interior designers, and landscape designers. She is a 15+ year veteran of the marketing and advertising industry, working closely with her clients to provide written content that meets their marketing goals and gets results.
Liyya is passionate about home design and décor and is a confessed HGTV and Pinterest addict. When not providing content writing services for her clients, she can be found browsing home décor sites or spending time with her family.