There are three schools of thought on how best to pay for a home.
The first camp aims to borrow as much as possible, putting down as little cash as they can. A second group fixates on 20% as the magic down-payment number. The third aims to borrow as little as possible, or even to buy the home entirely with cash if they can afford it.
It turns out they all are — or at least, there are legitimate pros and cons for each strategy. The answer also depends on your personality and risk tolerance. As you plan out how to pay for your next home, weigh these pros and cons to find the perfect strategy for your needs.
A Brief Overview of Mortgage Types
Many borrowers’ eyes glaze over when they hear pundits expounding on Federal Housing Administration (FHA) loans, VA home loans, and conventional loans.
Parsing the various mortgage loan types is a large topic, but you don’t need a Ph.D. in mortgage finance. You just need the basics.
If you’re a veteran who served in the armed forces, ask loan officers first and foremost about VA home loans. These loans allow as little as 0% down and often offer generous interest rates. Even better, VA loans don’t require private mortgage insurance either (more on that shortly).
For those without military service, the next best type of mortgage is typically a conventional loan. Conventional loans follow rigid loan programs dictated by government-sponsored mortgage giants Fannie Mae and Freddie Mac. But beware: These loans require reasonably strong credit.
Borrowers with less-than-stellar credit often opt for FHA loans, designed specifically to make homeownership possible for buyers with weak credit and little cash. They require a modest 3.5% down payment for buyers with credit scores as low as 580, and 10% down for buyers with credit scores ranging from 500 to 579.
The huge downside to FHA loans is that they require you to pay mortgage insurance for the entire life of the loan. Mortgage insurance protects your lender, not you — it’s insurance they take out against the risk of you defaulting on your loan. And you get the privilege of paying for it, usually costing you more than $1,000 per year.
Both conventional and FHA mortgage programs require borrowers to pay mortgage insurance. The difference is that conventional loans only require it if your loan covers more than 80% of the property value, while FHA loans require mortgage insurance until the loan is paid back in full…Read more>>