Smaller Down Payments

[Peter Cainero]

Hello,

I am in the process of looking for a property to house hack. I am looking at taking out a FHA loan to finance the property. The smaller down payment would be extremely beneficial to me at this point in my life. My real estate agent mentioned that I may not need a FHA loan in order to put down a smaller down payment. He said I may be able to put down a small down payment (3.5%) with a conventional loan.

Has anyone heard of this before? 

Thanks!

[Daniel Dow]

Peter, 

I am closing on a (non-investement) house tomorrow that was financed thru a conventional loan. The down payment I decided on was 5% at 3.625 % interest. My lender said I could have gone as low as 3% on the down payment - this is dependent on the lender. The interest was comparable to what I would have had thru an FHA, but I do have to pay all closing costs. With an FHA you can roll the costs into the loan. So why didn't I go with an FHA loan? Several reasons:

1. Annual Premium - FHA loans have expensive private mortgage insurance premiums (which is required of all loans where more than 80% is still owed), tacked onto the interest rate. This premium depends on the loan term and down payment, but can be as high as an extra 0.85%. When you're talking about sub 4% interest, that's a huge amount. As of this year, my understanding is that the premium applies for the life of the loan, not just the first 20% of principle. The only way to shake this premium is refinancing to conventional.

2. Lower equity - with FHA loans, closing costs are expensive, but you can often roll some or all of the closing costs into the loan and pay next to nothing at closing. This includes an upfront insurance premium of 1.75% of the borrowed amount. You might be willing to go this route if you want more cash on hand at closing, but your monthly payment will be higher and your equity will be lower.

3. Lower appraisal standards - When your lender is conducting their due diligence, their underwriter will send an appraiser to the property to determine if the condition is within acceptable limits for lending on. FHA underwriting is much more stringent, so if the house you want to buy is a fixer upper, it may not qualify. The house I'm buying has no finished floor or electrical fixtures; its a blank canvas. Otherwise it's in great condition, but it would not pass an FHA inspection.

4. 12 month rule - Typically, you cannot rent out a home that you have an FHA loan on until you have lived there for at least 12 months, unless you refinance to a conventional loan.

Hopefully that helped. Small down payment is only one part of a bigger picture. Don't forget to consider closing costs and condition/repairs (203k loans let you borrow for repairs, too). There are lots of benefits from an FHA loan, but there are drawbacks, too. Talk with your lender about your options.