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Pros and Cons of a Small FHA Loan Down Payment

fha loan down payment

It’s possible to get an FHA loan with as little as a 3.5% down payment, but does that mean you should stop saving once you reach that milestone?

The answer depends on your individual situation. There are some benefits in opting to make a small down payment, though you should also be aware of the potential downsides of this approach. In this guide, we’ll explore the pros and cons of a small down payment on an FHA loan.

3 benefits of a small FHA loan down payment

Here are three advantages of contributing a small down payment with your FHA loan.

You’re able to buy a home sooner

With a conventional loan, you’ll need a 20% down payment to avoid paying private mortgage insurance premiums on top of your monthly mortgage payment. It could take years to save up that much.

That’s one reason why FHA loans are so attractive. You may qualify to buy a home through an FHA-approved lender with as little as 3.5% down — provided you have a 580 credit score or higher.

On a $200,000 home, a 3.5% down payment is $7,000. If you put aside $300 each month, you could reach that amount in about two years. Saving for a 20% down payment on that same home, which equals $40,000, could take you a decade or longer.

You may grab a lower mortgage rate

Mortgage interest rates are generally moving higher. According to the Mortgage Bankers Association’s Weekly Mortgage Applications Survey, the average 30-year fixed-rate FHA mortgage was 4.70% in January 2019. A year prior, the rate was 4.16%.

Rates are expected to average 5.1% in 2019, according to a forecast from government-sponsored enterprise Freddie Mac. So, the sooner you buy, the better chance you have of snagging a lower mortgage rate. The smaller the down payment, the faster you can buy a house.

You’re able to conserve some of your savings

Because you’re subtracting just a small down payment amount from your savings account, you might have reserves left over.

Unexpected expenses will happen, and since you might not be completely draining your savings to cover your down payment, you have a better chance of being able to turn to your reserves to take care of those costs rather than credit cards or loans.

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3 downsides of a small FHA loan down payment

A small down payment isn’t free from disadvantages. Below we highlight and explain a few of them.

You start out with less equity

Your down payment is your skin in the game for a home purchase, and also your first chance to build equity. The more you put down, the more equity you start out with as a homeowner. With a lower down payment upfront, it will take you longer to build equity than if you had decided to contribute a larger percentage at the closing table.

You’ll pay mortgage insurance premiums

A small down payment means you’re required to pay mortgage insurance premiums in addition to your monthly mortgage payments. With FHA loans, there’s an upfront premium that is 1.75% of your mortgage amount — paid at closing — and an annual premium, which ranges from 0.45% to 1.05%, depending on your mortgage amount. The annual premium is divided by 12 and tacked onto your mortgage payments.

This extra cost will stick with you for the life of the loan, unless you refinance into a conventional loan later. The alternative is to put down at least 10% — that way, you eliminate your mortgage insurance premiums after 11 years.

Your interest rate will likely be higher

We previously mentioned that you could score a lower mortgage interest rate if you buy sooner rather than later. However, you might not qualify for the lowest rates if you’re putting down only a small amount. A higher interest rate means you’ll pay more interest over the life of your loan.

Put the cost of a smaller down payment in perspective by using LendingTree’s mortgage calculator and reviewing the included amortization table. Compare this with what that total expense would be if you made a larger down payment.

The bottom line

Depending on your financial circumstances and goals, it may benefit you more to commit to a small FHA loan down payment rather than waiting until you’ve saved more. After all, there’s a huge gap between $7,000 and $40,000.

Still, be sure you understand the costs of a low down payment and determine ways you can work toward saving more to lessen your cost burden.

There are state and local homebuying assistance programs available to homebuyers, especially first-timers. You may qualify for help with your down payment or closing costs through these initiatives. Visit the National Council of State Housing Agencies for more information.

Also consider saving more aggressively, depositing unexpected windfalls and suggesting monetary gifts from loved ones for birthdays and holidays instead of material objects — be sure it’s not a loan — to help you increase your down payment amount.

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