Sometimes you find a behemoth 127-year-old Victorian at such a major bargain that it seems silly to pass up—even if it’s much more than you intend to spend. So you decide to turn the top floor into a full-time Airbnb to help make the payments. But in order to keep as much money from your last home’s sale as possible, you opted to make the minimum possible down payment (3.5 percent) on an FHA mortgage.
(If you can’t tell—that’s what happened to me!) My husband and I put down $7,600 on our $200,000 house—way below the conventional wisdom approach of 20 percent down, and even less than the median of 6 percent down for a first-time homebuyer.
I think that if I had to do it again, I’d still do it. By holding onto our cash, we were able to pay outright for the majority of our (first round of) renovations. But there are some things I’d like to have not been in such a rush to gloss over—or wish I’d been able to predict—in my excitement over getting the house. Here, five things I wish I’d known before going with a low-down payment.
1. It’s going to be a giant pain to actually get the loan
To take the low, low down payment option, we had to do a FHA mortgage, which only requires 3.5 percent down. Unfortunately, it comes with a notoriously strict underwriting process and you have to use an FHA-approved appraiser. The seller almost didn’t want to take our offer when she learned that was our finance route.
But once our offer was accepted and the house was inspected, the real fun began. The lenders went through the photos with a fine tooth comb. They deemed staples in the hardwood flooring a trip hazard. They balked when they saw the third floor bathroom was missing a toilet. They cried foul when they saw paint peeling in the mudroom. We had to fix all these things before they’d make the loan. Since our seller was not exactly accommodating, we had to come in and pull staples, install a toilet, and repaint walls ourselves (all out of our pocket), which was quite a risk considering we didn’t know if we’d end up getting the place. (Thankfully we had a amazing realtor who spent a Sunday afternoon with us dealing with all these issues!)
2. The private mortgage insurance is a bummer
I was familiar with private mortgage insurance since we’d had it on our first home. In order to get a mortgage with a low upfront investment, you—the borrower—pay for insurance that covers the lender in case you default. It kicks in when you pay less than 20 percent down. There are some different types, and we previously had one that let the homeowner cancel it after reaching 20 percent equity in their home. On other conventional mortgages, insurance will automatically end when you reach a 78 percent loan-to-value ratio (though you can ask for it to be taken off when you hit 80!). But with an FHA loan, the private insurance is forEVER—the only way you can get it taken off is if you refinance into a conventional mortgage. That means as long as we’re making our mortgage payments, we’re paying $133 a month (almost $1,600 a year!) toward an insurance policy for someone else. That’s a lot of money that could be going to much better things and I hate that we have to pay it.
3. You get hit twice with mortgage insurance
If neverending PMI wasn’t enough, you get hit with an extra upfront cost with an FHA loan–an extra insurance premium (known as the Single Family Upfront Mortgage Insurance Premium). You pay it to HUD and it’s bundled in with closing costs. I had actually forgotten about this until I went back and looked at our closing documents (it was a stressful time I try to block from memory!). This added $3,377.50. Now in our case, we got the seller to pay some closing costs after the inspection, but that’s still some sticker shock. This additional cost–if you roll it into your mortgage–can also mean your monthly FHA loan payment ends up being higher than you’d have to pay with a conventional loan, even if the interest rate is a bit less.
4. It’s going to be hard to swap this loan for something better
Sort of like eating dessert first, we took the low down payment at the cost of being able to do something better later. We’d love to get away from frittering away that money on mortgage insurance every month, and one way to do that is to refinance into a conventional mortgage once we’ve built some equity. But having financed all but those few thousand dollars, we effectively trapped ourselves in this loan once interest rates started rising (and they’re rising). The thing about mortgages is they front load the interest on your payments, meaning the first few years you’re paying very little on the principal. That makes it super hard to make any headway paying down the original loan amount. So once interest rates start inching up–as they were bound to do when we took out the loan at a historically low rate like we did (3.875 percent!)–the math doesn’t pan out on a refinance. So we’re locked into this mortgage and insurance unless rates drop drastically in the future.
5. It’s harder to gain equity
Two and a half years in, we opted to do some major renovations to bring the house up to the level of homes currently selling on our couple of blocks. To foot the bill, we wanted to tap into the equity we’d built through improvements and property value increases. But you can only borrow a certain percentage of your home’s equity (the difference in what you owe and what it’s worth). Because we’d made so little progress on paying down the principal (see #4!) we were capped at what we could borrow, and therefore in the improvements we could make. (Which maybe isn’t so bad, because it keeps us from getting in over our heads.) The good news: This did force us to be creative and find compromises on renovations. Thanks to that, I think we’ve added more value than we’ve spent. But with interest rates going up, we wanted to make this our last hurrah and do ALL the work at once, which we ultimately weren’t able to do.