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?
We used a nearby loan broking, however the five% conventional loans are available from a number of the banks and credit unions round here too.
Michael | The Student Loan Sherpa says
We had to pay off some student loans to address debt-to-income ratio issues. As a result, we didn’t have 20% for a downpayment. The 5% conventional loan is a great option.
One other downside to the FHA loans that should be mentioned… The PMI is for the life of the loan. With a conventional loan, once you have 20% equity it goes away. Huge difference!!
I was fortunate enough to have a 20% down payment and went for a conventional mortgage, which allowed me to purchase a house that needed work. This is my second house and I did the same with the first house. There is nothing like having no debt, excellent credit, and some money to put down to give you options and a fast close.
My philosophy is to buy a fixer-upper that is livable and invest sweat equity with $ over time to bring it up to “jewel” status! Also never to buy the best or biggest house in a neighborhood.
However, one of my current sacrifices is to have lived in this house for 8+ years with a full brick wall in the LR that leaks, is cold in winter and hot in summer, and has a non-working fireplace. I’ve essentially boarded it up with pink rigid foam insulation while I save the money to have it replaced.
I bought my house 17 years ago. I have refinanced many times for lower interest rates. I currently have an interest rate 3.14% for 20 yrs. I have 10 more years left and it will be paid off when I am 55. For me conventional was the only way to go. I had PMI for about 2 years and then was able to get rid of it.
Proof of how debt versus no debt changes what you will get approved for in regards to a mortgage. We had $200,000 in student loan debt from my husband’s chiropractic schooling. We own our own business and went gazelle intense and were also very blessed and made a lot of sacrifices and paid it all off in 2 years. I went and met with a mortgage lender when we had the $200,000 in debt to see if we even had a prayer of getting approved for a home loan, they approved us up to a maximum of $480,000 and we had to have a minimum of 5% down. We prayed and felt strongly we needed to pay off all our debt before we took on a mortgage. Fast forward 2 years later and after we paid off all our debt and and our income only went up by about $40,000 per year, we just got approved for up to a $1.8 million home loan. (we make about $200,000/yr now) Debts, especially large debts, count again you huge.
Of course we are not going to be ridiculous and get a $1.8 million home, we will get one between $300,000-$400,000, but it is just nice knowing that we will have literally no other debt payments than our home when we get one and even then, we’ll pay it off early. It’s amazing how much better we sleep at night and how less anxious I am now that we’re debt free. Well worth it.
I also went for the conventional loan with about 5% down payment! I didn’t want to pay the PMI through the life of the loan and liked the better interest rate. I also went for a home that was $25k less than what I qualified for because I didn’t feel comfortable spending that much. I’m now actively working to pay down my principal so I can get that PMI kicked off as soon as possible!
Natalia Soares says
What bank did you use to get 5%?
I think mortgages are different in some respects in the UK, but I’m no expert as I’m long retired and mortgage ( on very small house!) paid off.
Since the financial crisis almost 10 years ago it’s increasingly difficult to obtain mortgages and my daughter and her husband stand no chance until I die and leave her my property. It’s very difficult for young people in Britain to get on the house ownership ladder.
My husband and I bought our first house in 1973 for £5500 with a deposit of £1000. Over the next couple of years the interest rates rose to almost 14%. Some months we almost had to choose between paying the mortgage and eating. It was a nightmare time for thousands and thousands of people. But it taught me even more about money management. I’ve never known any other way than ” living on last month’s money” 🙂
Very best wishes to you and your family in your new home.
We did exactly what you did- and it made sense for us as well. Our interest rate is low (very low now, after refinancing several years ago). And we were able to get rid of the PMI payment recently. Just so you know, make sure you don’t refinance right before you will be due to be able to get rid of the PMI payment. We found out the hard way, that, at least in our case, they require you to have the loan for a certain period of time before they will let you drop the mortgage insurance. They went from the date of our refinance- rather than our original date (making us call back 6 months later to finally get it removed). Good luck!
Amy L says
We paid extra on our 30 yr conventional mortgage (5% down) to get rid of our PMI in approximately 14 months but we had to pay for a reappraisal to have it removed. (It was cost effective vs the amount of monthly PMI.) However, 6 months later we decided to refinance (to a 15 year mortgage with super low interest rate) which required another reappraisal. Ugh. We should have just refinanced and did everything at once. Live and learn. (I’m curious what the behavioral economists would say about our inability to save for a 20% down payment before getting a 30yr mortgage but somehow we were able to get to 20% when we had a bill coming every month. Slightly in the bizzaro world.)
Natalia Soares says
What bank did you use to get 5%?
We used a local mortgage broker, but the 5% conventional loans are available from many of the banks and credit unions around here too.
We used USDA. It was perfect and we were so grateful because we needed a house but didn’t have a down payment saved. I would have LOVED to get an old fixer-upper, but I have to admit that our turn-key ready house that we decided on (and that qualified for the USDA loan) has been pretty nice. We’ve still been able to do little updates to make it our own, without having to deal with the issues that an older house brings. Some people think the USDA program is for very low-income people only, but we still qualified and we both had full-time, stable jobs with decent income. It did mean taking on a bit larger loan (due to the no down-payment), but we are diligently paying extra on the principal to make up for it. 🙂
Mrs. Daisy @ Dirt Road Daisy says
Thank you for putting all of your personal business out there for us to read! We are still tackling student loan debt before we purchase a home, but have looked into the options and spoke with a banker to determine that would make us ideal mortgage candidates so that we know when we’re ready. I think that doing the due diligence beforehand will pay off tremendously. We had friends recently attempt to go get a mortgage. They thought they were in great financial shape and would have no problem getting approved. However, they said the mortgage lender basically laughed at them (not great business tactics). But they were grateful for it because it got their butts in gear! I’m anxious for your post on why you didn’t wait to get 20% down!