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Mortgages and the myth of the 20% down payment
Happy holidays everyone! I hope everybody got their fill of christmas ham this past week! I spent my christmas in West Palm Beach relaxing by the pool with my parents and working on my tan. It was definitely nice to dodge the polar vortex for a few days. Recently we've been chatting within my real estate team about common misconceptions that people have about real estate so I've decided to start blogging about some of these topics.
I think the one I hear most often is the myth of the 20% down payment. Since I've been in real estate, someone tells me at least once a week that they'll never actually be able to save up the money for a down payment. As daunting as it can sound, you really don't need more than 3.5% to 5% of the total cost of the house to get your foot in the door (no pun intended). Before we talk about where the 20% comes from, I should define the two most popular types of loans.
FHA – These loans come from private lenders that are federally regulated and are insured by the Federal Housing Administration. Notable guidelines to know are:
- FHA loans allow for a lower credit score than conventional loans
- The down payment for an FHA loan can be as low as 3.5%
- They require mortgage insurance for the duration of loan (typically 30 years)
Conventional – Conventional loans are loans that are less restricted by government regulation. These loans are harder to get but generally save you more money in the long run. Notable guidelines for these loans are:
- Requires a minimum 620 credit score
- Must have a minimum down payment of 5%
- Only requires mortgage insurance until your home equity reaches 20%
Both loans include a stipulation that requires something called private mortgage insurance (PMI for short) which insures any losses the bank might face if you were to stop making your monthly payments and lowers their risk. On a loan with PMI, you pay for the bank's insurance as part of your monthly mortgage payment. A lot of times FHA loans are advertised having lower interest rates than conventional loans but sport higher PMI costs. This creates the misconception that FHA loans are superior when in actuality they end up being more expensive in the long run. Conversely, a conventional mortgage actually ends PMI at 20% of the loan amount which means that you'll see a reduction on your monthly payment in 5-7 years. This is where the 20% comes from. While PMI might add a little to your monthly bills, in the long run it enables you to start building equity now.
If you're considering buying in the next year, please reach out so we can connect you to a reliable mortgage lender. They'll be able to access your credit and create an action plan to help you prepare to get approved when you're ready! For my next blog post, I'll writing about free down payment assistance programs that most people don't know exist.
Luis Catalan, Broker Associate