Since I announced that we’re six figures under again (because we bought a house) I’ve received lots of questions about our mortgage. When you’ve shared all of your financial details with the world for years, I suppose that is to be expected! I’m happy to oblige.
When we finished paying off our enormous law school debt, we were itching to start house hunting even though we were working toward some other pre-house goals. We met with a loan originator soon after paying off our debt to get an idea of what our options would be and how much we needed to save. We discussed several types of financing that might work for us.
In addition to doing our due diligence on the loan side, we took a serious look at our finances to decide on a price range and monthly payment that we were comfortable with. I’ll go more into detail on how we decided on our house budget in a future post.
Side note: I would never finance any other purchase based on the monthly payment (can’t you just hear the salesman say, “Well that’s just $$$ a month—surely you can do that!”). I think a house is a little different. It’s crucial that you look at both the big picture and the monthly impact.
We had our loan originator run various scenarios for us so we could compare apples to apples as much as possible regarding our financing options. Seeing what the monthly payment, down payment, closing costs and interest rate (both rate and APR) would be for each of the options was very helpful in finding the best loan for us.
Starting out, one of the most attractive options was the USDA loan, also called the rural development loan.
Some of the big draws of the USDA loan are that no down payment is required and the mortgage insurance premium is low.
Right around the time we started looking at houses, the UDSA loan got even more attractive. When you get a USDA loan, they tack a fee on right in the beginning. Up until October 2016, that amount was 2.75%. So a $100,000 loan was actually a $102,750 loan. In October, the upfront fee went down to 1%, making it an even better deal!
The hard part with USDA is finding a property that qualifies. All of the areas that we were interested in met the rural location factor (it’s broader than you might expect), so we were hopeful that we could take advantage of this great option.
In addition to the location restrictions, there are restrictions on price (varies by area), size (varies by area), and other details. For example, it can’t be set up for a potential income-producing enterprise (i.e. hobby farm, rental unit, etc), it cannot have a swimming pool, and (oddly) it cannot be on a gravel or dirt road.
While we really hoped to get a USDA loan, it mostly depended on whether the property we found would fit. As it turned out, the property we found, fell in love with, and knew was right for us would not have qualified for a USDA loan.
The FHA loan seems to be a common default for people who don’t have 20% to put down. Instead of 20%, the FHA loan only requires a 3% down payment. My guess is that many people go straight for this option without checking anything else. We almost did!
When comparing the FHA loan with the other options, there were some glaring downsides. The interest rates were high and private mortgage insurance was also high.
What the FHA has going for it is that you don’t need very high credit scores to qualify. Of course, that’s also the reason that the interest rates and mortgage insurance are higher, because there’s more risk involved for the lender.
The more we thought about who the FHA loan is aiming to serve (small down payment, medium credit scores), the more I realized, that we don’t completely fall into that category. While we didn’t yet have a lot of cash for a down payment, we do have excellent credit scores.
That’s when I asked to see what a conventional loan with 5% down would look like.
Conventional, 5% down
With our credit scores we were able to get a better interest rate with a conventional loan that what the FHA loan offered us. What got me even more excited was that the mortgage insurance payment was less than half of what it would have been with an FHA loan. Our monthly mortgage insurance payment with a conventional loan was less than what it would have been with an FHA loan.
Of course we did have to have to put more money down (5% instead of the 3% required with FHA), but we were able to make it work.
There are other perks to having a conventional loan. With an FHA loan, there are pretty strict guidelines for the properties that will qualify (USDA is even more strict than FHA). If your house needs some repair, it probably won’t qualify. They don’t want you to default on your mortgage because you are up to your eyeballs in expensive repairs. That makes it a little harder to find something below market value (i.e. sells for less because it needs some love) that you can put some work into to raise the property value. Conventional loans aren’t as strict about this.
Another perk is that you can get the mortgage insurance removed on a conventional loan. This is not possible with USDA or FHA loans anymore. Getting out of mortgage insurance with USDA or FHA loans requires a refinance, which means you’re at the mercy of the interest rates when you’re ready to refinance. If the rates are higher when it’s time to refinance, you’re out of luck.
Ultimately, a conventional loan with a 5% down payment was a much better option than an FHA loan for us.
What should you do?
While we are happy with how everything worked out for us, your details are quickly likely different from ours. What worked for us might not work for you and vice versa.
If you’re trying to decide between a USDA loan, FHA loan, and conventional loan (or any other type of loan, for that matter), I encourage you to compare the loans using your specific details (not just some chart you find online). Have your loan officer run the comparisons using your real credit score, the current interest rates, and the same house price, so you can better compare apples to apples.
In your case there may be other loan options you want to explore as well. Seeing all the numbers laid out side by side will help you see and weigh all the factors, both long term (total cost of the loan) and short term (down payment, closing cost, monthly payment).
Why didn’t we wait until we had saved 20% to buy
Lots of people were surprised to hear that we bought a house before we had a 20% down payment. After seeing the somewhat extreme measures we took to pay off our hefty debt fast, it may seem surprising that we are willing to pay private mortgage insurance at all.
The answer is more than just being eager to get a house (though I’ll admit that is part of it). I’ll address our decision to buy before we had 20% down in detail soon.
How about you?
- Do you have a USDA, FHA, or conventional loan?
- Why did you choose it over the other options?