On Wednesday we went over why it is important to know your credit report info and credit score at least a year ahead of when you’re planning to purchase a house. Today is the second part of things you should do at least a year in advance of buying a house and we’ll be discussing whether or not a small down payment is actually a big deal or not.

An Example of a Small Down Payment Mortgage – FHA Loans

When you don’t have a large down payment of at least 20% and you’re trying to buy a house, FHA loans are one option that has been popular in the last few years due to the low minimum down payment of 3.5%. Unfortunately, these mortgages have a ton of fees and they’ve recently drastically increased. Now more than ever, you really do pay for having such a small down payment and weren’t not talking just a few bucks. We’re talking thousands of dollars.

Due to putting down such a low amount of money, you will be required to pay mortgage insurance premiums and it won’t be just once. When you take out the loan you’ll have to pay an  up front mortgage insurance premium (UFMIP) of 1.75%. Since you likely don’t have the money to pay this up front, they will incorporate it into your mortgage loan amount.

This means, in addition to paying a UFMIP of 1.75%, you’ll be paying interest on this up front premium over the life of the loan which could be as long as 30 years. On a $200,000 mortgage this fee would end up being $3,500 before you pay any interest on the premium you rolled into your mortgage over the 30 year life of your loan. There is a way to avoid this pointless fee… but first there is some more bad news.

If that was the only fee, it wouldn’t be the end of the world. You’d just be paying a few thousand more than you should. I wish you could see my eyes rolling… However, things get much, much worse with the new FHA rules that have taken affect in April 2013. In the past, you’ve always had to pay annual mortgage premium insurance until your loan to value ratio (how much principal you owe on your loan versus the value of the house) decreases below 78%. That is changing.

From April 2013 forward the annual mortgage premium insurance will no longer be cancelled when your loan to value ratio goes below 78%. You have to pay it for the entire length of the loan. It won’t ever be cancelled. Total bummer for anyone who thought a FHA loan was a viable option.

If that wasn’t bad enough, the FHA annual MIP is increasing to 1.35% every single year if your loan to value ratio is greater than 95% and 1.30% annually if your loan to value ratio is less than 95%. Talk about crazy additional fees for the next 30 years of your 30 year mortgage!

So what is this second secret that you can follow to save thousands and thousands of dollars over the life of your mortgage? It’s pretty simple.

Have a Proper Down Payment

It seems so simple to have a proper down payment of at least 20% when you buy a house but it isn’t an easy feat to accomplish. That’s why you need to start saving at least a year in advance in order to reach that 20% down payment. For many people it’ll take many years to save that down payment but it is worth it. By putting a 20% down payment on your new house you won’t have to pay the up front mortgage insurance premium of 1.75% or the annual mortgage insurance premium of 1.35% (or if you’re lucky and put 5% down, 1.30%).

Yes, it takes a while to come up with a proper down payment. No, it isn’t fun sacrificing to be able to save the money. That sacrifice could easily save you tens of thousands of dollars over the life of your mortgage.

Which is more important to you? Having a house today and paying thousands of dollars extra for it? Or waiting and putting down 20%?

P.S. Yes, I know it isn’t that simple. Times change, house prices can increase and mortgage rates can do the same. You might end up better off in the future if you get an FHA loan today than if you put 20% down on a house 5 or 10 years from now. Unfortunately, no one has a crystal ball and time machines haven’t been invented yet so you’ll have to make that decision for yourself. I’m just presenting the options as I seem them today.

That sounds horrible… doesn’t it? Don’t worry though. It isn’t as bad as it sounds! We only signed a mortgage!

In the last few weeks I read that mortgage, if broken down into parts, actually means death pledge. Supposedly the term mortgage comes from the old french word mort, which means dead, and gage, which mean pledge.

It has a somewhat double meaning since if you die without repaying the debt, the bank gets your property if it isn’t paid off by your estate. However, if you retire your mortgage by paying it off prior to your death you have killed the debt!

Why We Made a Death Pledge (Took Out a Mortgage)

As I had mentioned in the past, we were in the process of looking for our next home! We couldn’t pay cash for our new house so we had to take out a mortgage. Even if we could have paid cash, I still would have taken out a mortgage in today’s extremely low rate environment.

Our townhouse would have suited us for a few more years but we would eventually want to move away from the beach and into town and have more space. The minute we have a child the townhouse would have become really cramped. The new house is large enough for us to live in for at least 10-15 years, if not the rest of our lives.

The new house is also in a neighborhood we feel much more comfortable about. The house is in a more stable neighborhood where there are many more owners than renters and everyone actually comes out and says hi to you.

The townhouse neighborhood has a lot of renters and is somewhat on the sketchy side at times but we were well aware of it when we bought it. We knew it’d be fine for us until we had kids. The biggest reason we were OK with it was because it was 3 blocks from the beach and the price made it a complete steal! You can’t beat that!

The townhouse was a great rental opportunity and we knew that when we bought it. We can rent it for a good bit above the mortgage, insurance and taxes. That extra should easily cover maintenance and vacancy times. Eventually we’ll have a paid off townhouse close to the beach paid by our renters! How awesome is that?!

But Why Buy Now?

Initially it wasn’t the plan to buy a house in town so soon after buying the townhouse, although we always knew we eventually would. After considering the alternatives and looking into the future it made more sense to make the move now.

Should We Have Renovated?

If we were going to stay in the house for the next five years there were some pretty expensive improvements we wanted to make. We wanted to gut the kitchen and redo the full and half bathrooms and that isn’t cheap. It wouldn’t work out well for us when we go to rent out the townhouse in the future.

The rental market in our area wouldn’t be able to handle the increase in rent that would need to occur to offset the cost of the new renovations. Our townhouse is already toward the nicer end for the neighborhood and putting in an awesome kitchen and nicer bathrooms would put our townhouse in the even nicer house in the not so nice neighborhood category.

We knew these renovations would only make the townhouse nicer, not bigger, so it wouldn’t extend the amount of time we could continue to live in it. It didn’t make sense to us to sink money in the townhouse if we wouldn’t get it back.

Low Rates and Low Prices

I’ll admit that I don’t have a crystal ball and I don’t pretend to either but the mortgage interest rates have been so low lately (less than 4%) and we don’t think they’ll stay that way for another 5 or so years. Increases in mortgage interest rates have a large effect on how much house you can buy for the mortgage payment (assuming you keep the down payment the same). Even moves as small as a quarter of a percent can make a big difference in your mortgage payment.

The other factor we considered was home prices and the local inventory levels. Home inventory levels have been shrinking and home prices have begun to creep up. It could be a false positive or it could be the bottom in our area. Either way, we don’t feel the housing market has much room to move down in our area over the long run. After all, we’ll be in this house for at least the next 10 years!

What are your thoughts on the current housing situation? Do you have a strong opinion on death pledges? I’d love to hear your thoughts in the comments!

No, This Isn’t The House

We recently have felt like we had come down with a bad case of tunnel vision in regards to paying down my fiancee’s student loans. When we realized the fact that we had developed tunnel vision we evaluated our priorities and our future goals and decided that we needed to make an adjustment to our plans.

Change of Plans

We’re buying a house! There I said it. I know this decision won’t be very popular with those who advocated eradicating all debt as soon as humanly possible, but we live our life according to our personal priorities and our priorities have changed.

We aren’t buying those beautiful beach front condos that we considered just a month or two ago. The views were awesome but they just weren’t that practical. Instead we’re buying a house in town which is closer to both of our jobs and other places that we frequent.

Why We Decided to Buy a House

We always knew that we wouldn’t live in our townhouse that we bought on a whim forever. We originally had thought we’d live here for five to ten years but after living here for a year and a half we realized that we had two options. We could either renovate and update the townhouse a bit or move on to our next house.

The original plan was to renovate the townhouse after we paid off my fiancee’s student loans. If we completed our original goal of paying her student loans off by the end of 2013 that would mean we’d renovate the townhouse sometime in 2014. We would want to completely renovate the kitchen and both bathrooms.

As I’m sure you know, kitchens and bathrooms are some of the most expensive home renovations you can take on. They generally pay back decently, but it is unlikely you’ll get the full cost of the renovations back when you sell. The thing is, we don’t plan on selling the townhouse anytime soon, if ever.

We’d be able to enjoy the renovations for a few years but we knew we would move into town eventually. When that day came we planned on renting out the townhouse. I’m sure the renovations would make our townhouse highly desirable because none of the rental properties around it would have similar upgrades.

The problem with the renovations is that when we rent the townhouse we’d have to price our rental property much higher than the market for the surrounding area in order to recoup our remodeling costs. It isn’t likely we’d be able to pull that off and it was the main factor that drove us to buy our next house now rather than a few years down the road.

But What About the Student Loan Pay Off?!

The student loan pay off plan was the hardest part of our decision. We really wanted the student loans to be gone and we were on track to pay the off by the end of 2013 according to our February Debt Pay Off Update. However, in order to buy the house in town we’d need to (well… want to) put 20% down.

The down payment on the house would completely eat up my stash of cash that we had planned on using to pay down the student loans after we get married. So what did we do? We analyzed the difference between paying the loans off by the end of 2013 and the new likely pay off date, the end of 2015/early 2016. Since the interest rate is lower than cash loans, it didn’t extend the pay off date very far.

The results were a bit surprising. While we delayed the payoff date by two years the total interest paid on the student loans only increased $3,000! Now I’m not saying $3,000 isn’t a lot of money, because it is… What I am saying is that in the big scheme of buying a house, paying an extra $3,000 to pay off student loans 2 years later could be well worth it. How do I figure?

Why Buying a House Now Makes Financial Sense to Us

There are two key costs in buying a house. The price of the house and the interest rate on the mortgage. I’m not as worried about the first cost as I am the second cost.

The media has been hyping the recovering housing market lately so it seems like prices are going to be on the rise sometime in the next couple years. I don’t expect any rapid price increase, but it only takes an increase of $3,000 in the price of a house to make our decision of delaying paying off the student loans to make financial sense.

Interest rates are where the true savings come in. If we end up with a $100,000 mortgage and rates rise just 0.25% our total mortgage cost will go up over $5,000 over the course of the loan. If we end up with a $150,000 mortgage and rates rise just 0.125% our total mortgage cost will go up almost $4,000 over the course of the loan.

We looked at the numbers and took emotion out of the equation. Overall, it just made more sense for us to buy a house now even though we’d love for her student loans to be gone. We’ll also be happier with the extra space we’ll have in the new home and we’ll save a ton of time and money in commuting and traveling costs.

What do you think of our decision to go ahead and buy a house now and delay the student loan pay off debt? Is your decision influenced by the fact that you hate debt, or did we miss something from analyzing the numbers of the situation?