Why would anyone bother with a 5% down conventional loan when the 3% down conventional loans are available? If you are not a first time home buyer, your income is not 100% or less of the medium income level or the home is not in a low-income census track area then you will not qualify for the 3% down conventional loans. Let’s assume you do not want an FHA loan because you don’t want to deal with mortgage insurance for the life of the loan. Or you keep seeing “cash or conventional only” on most of the houses you like. There is nothing wrong with the houses the seller just wants a quick closing. You are not a veteran and you don’t live in a rural area so VA and USDA loans are out. NACA sounds great, but you are concerned about the long waiting periods for approval and to close on a loan. Where does that leave you?
Luckily, you have more choices than 0%, 3% and 20% down loans. You’re next best option is a 5% down conventional loan. Conventional loans that allow 5% down payment are still much cheaper than having to put 20% down while still offering the benefits and confidence of a traditional quick close. Ideally, if you can afford the extra 2%, conventional loans are usually the better way to go over FHA. This isn’t always the case, especially if you are considering getting a 15 year mortgage. Always make sure you are getting the best loan product out of any programs you qualify for. However, under most circumstances here are three (3) reasons to go conventional 5% down over FHA 3.5% down.
FHA loans charge an upfront mortgage insurance premium (UMIP). The UMIP is 1.75% of the loan amount. This means, the real savings of an FHA 3.5% down loan is only .25% less than a 5% down conventional loan.
You cannot cancel the mortgage insurance premium, ever, on the FHA loan unless you put at least 10%. Again, you are only about .25% more in cost on a conventional loan. And, once you are able to cancel the monthly mortgage insurance on your loan the payments will go down. This is a money saver on conventional loans.
The entire 5% down for your conventional loan is going towards your principal balance. FHA allows you to roll the UMIP of 1.75% into your closing costs. If you do this, it effectively means, instead of having 3.5% equity in your house you now have 1.75% equity in your house. If you pay the fee out of pocket, that 1.75% more you have to bring to closing. At this point the conventional loan is looking a lot better – even if you cannot get one of the nifty 3% down loans.
A Real Example – 5% Down Conventional Loan
In the below example, the borrower is purchasing a house for $205,000 with a 5% down conventional loan in Georgia.
The borrower’s middle score is 710 and is self-employed with one year of tax returns.
The borrower also has paid off a Judgment for $8051 showing on their credit report. The judgement has been updated by all bureaus to show paid.
Some of these conditions have caused the interest rate to be a little higher.
The borrower was given two options for a 30 year fixed conventional mortgage with 5% down:
- Option one – Lender paid mortgage insurance (MI). This loan has a higher interest rate, but lower payment (100% of interest can be written-off on taxes). The interest rate is higher to account for lender paid MI
- Option two – Borrower paid MI. lower interest rate, but higher payment (not able to write-off mortgage insurance for tax purposes usually). The interest rate is lower because the buyer paid their own interest.
The borrower chose option 2 and paid the MI upfront to capture the lowest payment and interest rate. The final settlement statement (HUD-1), is below. The names of the companies, buyer(s) and seller(s) have been blocked out for privacy.
Notice the cash from the borrower required to close is 17,199.96. But, if the MI was not included in the loan this will reduce the closing cost by 4829.80 (the cost of the mortgage insurance). The total amount to close would have been $12,370.16.
Calculating Mortgage Insurance
Mortgage insurance is calculated on conventional loans by estimating the amount of time it will take to reduce the loan amount to 20% of the amount borrowed. For example;
- Assume the loan is closing on November 1st 2016.
- The sales price is $205,000.
- The borrower put down 5% or $10.250 which means the balance being financed is $194,750.
- 20% of $205,000 is $164,000.
- It will take the borrower until December 1st 2024 or 8 years to pay the mortgage down to $164,000 (or 20% of $205,000) from the 194,750 balance.
- The mortgage insurance premium of $4829.80 / 8 (years) is 603.63 year premium.
- 603.63 / 12 (months) is 50.30 per month. This would be added to the monthly payment of 1287.07.
- This means the mortgage payment for years 1 – 8 would be 1,337.37
- The mortgage payment for years 9 – 30 would be 1287.07