When we purchased our first home we went with an FHA mortgage loan that allowed us to put down just 3.5% of the home price. This low down payment mortgage option allowed us to buy our first home without saving up much money, but was it worth it?
Today I’m looking over the pros and cons of choosing a low down payment mortgage. It it worth it? Should you put a low down payment on your home purchase?
What are low down payment mortgage loans?
A low downpayment or low deposit mortgage is a type of mortgage that requires you to pay a very small amount of money into the loan initially.
These are often used by first time home buyers who are unable to save up the full recommended 20% down payment.
Certain loans allow you to purchase a home with less than 20% down and even as low as 3.5% down.
With conventional mortgage loans you can generally go as low as 10% down or occasionally some even allow 5% down payments. Traditional financing may require you to pay 20 percent or more as the down payment depending on the market you are in and your credit score.
These low downpayment loans may be called any of the following:
- low downpayment mortgage
- no money down mortgage
- $0 down payment mortgage
- USDA mortgage loans
- FHA mortgage loans
If considering these types of mortgage loans you should research the types of loans you can get with small down payments.
When to use a low downpayment mortgage?
Determining the right mortgage for your situation should be made with a mortgage professional and a lot of personal research.
Depending on your market and the economy you may or may not be able to use a low down payment mortgage loan to purchase a home.
After recessions these loans are harder to secure, but if you are a first time home buyer they can help you achieve home ownership more quickly so your money is going toward equity rather than rent.
If you are considering a low deposit mortgage then you need to consider the pros and cons associated with this type of mortgage.
Depending on your situation and long term plans a low down payment mortgage could be a useful tool or one of the common first time home buyer mistakes.
Low down payment mortgages tend to be used more often when home prices or interest rates make mortgages less affordable. People who want to get into their home faster often sacrifice the best long term financial option with these mortgage.
But is it the right solution for your situation?
Let’s look at some pros and cons of mortgages with low down payments.
Pro: Getting Into Properties Faster
The number one pro of a low down payment is that you are able to purchase a property faster. This is especially useful when you do not own any properties at all and are purchasing your first residence.
The existence of low down payment mortgages is there to help out first time home buyers and it’s one of the many ways that first time buyers are able make their first home purchase.
You’ll notice that mortgages for rental properties are not generally eligible for low down payment loans and usually requires a higher down payment.
Low downpayment mortgage options let people get into a property faster because they don’t have to wait the extra months or years in order to save up a full 20% down payment.
For some markets being able to use a smaller down payment can get you into a property years faster.
Pro: Increased Availability of Money
One important consideration is the availability of assets like cash in your bank account.
One of the main differences between low deposit mortgages and a traditional mortgages can seem useful to home buyers: you have more money left in your bank account.
If the deposit on a traditional mortgage may empty out your bank account entirely, then a low deposit mortgage may be a better option for you. Having more money in the bank after your home purchase
Homeownership has many expenses associated with it like:
- new furnishings for the home
- unexpected repair costs
- regular maintenance costs
- increased utility bills
- insurance costs
- property tax bills
- and more!
Many homeowners will enjoy greater financial security at first and long term with more cash in the bank. Having a larger emergency fund is always a great idea as a homeowner.
You definitely don’t want to buy a house and only be left with a $1,000 emergency fund!
When an emergency comes along you are going to appreciate having a larger emergency fund. Using a low down payment for your home purchase allows you to keep more money and be more prepared for emergencies.
Con: The Interest Rate
One of the most significant drawbacks associated with applying for a low downpayment mortgage relates to the interest rate of the loan.
Unfortunately lower down payment loans often come with higher interest rates.
When you shop around today and compare different loans, you may notice that the interest rate on low deposit mortgages is considerably higher than the rate on mortgages with a more traditional or higher deposit requirement.
The interest rate on your mortgage can ultimately affect your monthly payment as well as your ability to repay the outstanding balance. The higher your interest rate the more you will pay for your house in the long run.
When interest rates are already high for mortgages taking on an even higher rate can be a bad choice. You can hope to refinance lower later but you have no control over when lower rates will actually arrive.
Con: Higher Monthly Payment
When you are trying to decide what type of mortgage to get, you need to consider the fact that the low downpayment mortgage will have a higher monthly payment.
Increasing your monthly spending with a large house payment should be factored into your decision.
With a lower down payment, the monthly payment for your mortgage will be higher because it is based on the total amount borrowed, the interest rate and the loan term.
Both the total amount borrowed and the interest rate are generally higher with the low downpayment option, and because of this, the monthly payment may be significantly higher.
While it may be easier to afford a low deposit mortgage’s deposit requirement initially, you should consider how the higher monthly payments will affect your budget for years to come.
You’ll want to run a new budget based on different monthly mortgage payments and see which will work best for your life.
Is a low downpayment mortgage right for you?
If you have been thinking about applying for a mortgage and are debating between a low down payment mortgage and a mortgage with a higher deposit requirement, each of these points should be considered carefully.
Do you want to spend more upfront or more in the long run? This is the essential question for choosing a mortgage with a low downpayment.
Depending on your financial situation, you may find that one option is more suitable for your needs than others.
The real question you need to ask after considering the pros and cons: is a low down payment mortgage the right choice for you? Only you can answer that question because it will depend on your personal situation, income, and risk tolerance.
If you are interested in this approach then you should definitely do your research and run the numbers first. It’s a path that can pay off but is financially risky!
Mary is the founder of Pennies Not Perfection where she shares her journey to build wealth through online income. She quit her day job in 2021 after she paid off her debt and doubled her 9-5 salary.
Mary's favorite free financial tool is Personal Capital. She uses their free tools to track net worth and work toward to financial freedom.