One of the biggest barriers to home ownership for first-time buyers burdened by record-high student loan payments and soaring rent levels has been the difficulty of amassing a down payment.
To get past that hurdle, today’s buyers are increasingly turning to loans with lower down payment requirements, even though doing so requires mortgage insurance and higher monthly payments. Selecting the wrong down payment loan, however, can be a costly mistake, and the decision can get complicated.
Low down-payment borrowers are 51 percent more likely to opt for Federal Housing Authority loans over private loans, but that’s not always the best choice.
On a loan with a 5 percent down payment, borrowers with above-average credit scores could save up to $8,000 over the first five years of the loan by choosing a loan with private mortgage insurance, according to a new analysis by WalletHub. For those with lower credit scores, however, opting for an FHA loan could mean a savings of up to $11,000 in the first five years.
However, the longer you plan on staying in a home, the more savings you’ll see by opting for private mortgage insurance. On the same home in the example above, a borrower with a credit score of 680 will have paid nearly double the amount of mortgage insurance on an FHA loan as on a private mortgage.
That’s because private mortgage insurance goes away once you’ve built up more than 20 percent equity in a home, while FHA premium continues through the life of the loan. FHA borrowers could refinance to a more traditional mortgage once they’ve passed that equity threshold, but they’d be subject to current mortgage rates, which may be higher in the future.