Does It Ever Make Sense to Put 20% Down on an FHA Loan?

FHA loans allow borrowers to make a down payment as low as 3.5% of the purchase price. But some home buyers choose to put 20% down in order to reduce their monthly payments.

The question is, does it make sense to do this?

Read on to find out why a 20% down payment for an FHA loan might be a bad idea for some home buyers, and a good idea for others.

Minimum Down Payment for an FHA Loan: 3.5%

Federal Housing Administration (FHA) home loans have been around since the 1930s. This program is geared toward borrowers with low or moderate income who are seeking a low down payment option.

This program also offers more flexible qualification criteria, when compared to conventional or “regular” home loans. 

FHA loans are a type of government-backed mortgage. Borrowers apply for these loans through a mortgage lender in the private sector, just like any other type of home loan. The difference is that FHA loans receive federal insurance backing that gives mortgage lenders additional protection. 

The minimum down payment required for an FHA loan is 3.5% of the purchase price or appraised home value, typically whichever is less.

In contrast, the minimum down payment for most conventional home loans ranges from 5% to 20% depending on the circumstances.

(Though there are a few conventional products that allow for a down payment as low as 3%, such as Freddie Mac’s Home Possible.)

Mortgage Insurance Always Required for FHA

All home buyers who use an FHA loan must pay for mortgage insurance.

In a sense, the FHA loan program functions like one big insurance fund. Borrowers pay into the fund. The Federal Housing Administration manages it. And mortgage lenders benefit from it with reimbursements in the case of default.

There are actually two kinds of mortgage insurance required for FHA loans:

1. Upfront Premium of 1.75%

All home buyers who use an FHA loan have to pay an upfront mortgage insurance premium that equals 1.75% of the base loan amount. Even if you put down 20% on an FHA loan, you’ll still incur this one-time premium. You can pay it up front (at closing) or roll it into the loan.

2. Annual Premium Ranging From 0.15% – 0.75%

Borrowers must also pay a recurring annual insurance premium for an FHA loan. The annual premium can vary based on three factors:

• The amount of money being borrowed
• The loan-to-value (LTV) ratio
• The loan term or length

Most borrowers who use this program make a low down payment, which is one of its main benefits. Those borrowers usually have an annual mortgage insurance premium of 0.55%.

Borrowers who put down 20% on an FHA loan typically pay a lower annual premium. That’s because they reduce the overall risk level by investing more of their own money.

There’s another important difference, when it comes to canceling the annual insurance:

• If you put down less than 10% on an FHA loan, you will probably have to pay the annual mortgage insurance premium for as long as you keep the loan. In other words, it will stay with you until you either sell, refinance, or pay off the loan.
• If you put down more than 10% on an FHA loan, your annual mortgage insurance will expire after 11 years. After that, you won’t have to pay it anymore.

How Private Mortgage Insurance (PMI) Works

A conventional loan is one that’s not insured or backed by the government. This term is used to distinguish them from government programs like FHA and VA.

Unlike the FHA program, conventional loans only require mortgage insurance in certain situations. If a home buyer takes out a conventional loan for more than 80% of the home’s appraised value, they will probably have to pay for private mortgage insurance or PMI.

PMI is usually required for conventional loans with a loan-to-value (LTV) ratio above 80%. This is why many borrowers who use conventional loans choose to put down 20% or more. They do it to avoid having to pay PMI on top of the principal and interest.

But with an FHA loan, you’re going to pay mortgage insurance for at least 11 years, even if you make a down payment of 20%.

Pros and Cons of 20% Down on an FHA Loan

If you can afford to make a down payment of 20%, mortgage lenders are going to love you. Especially if you have steady income and good credit.

A down payment of 20% significantly reduces the mortgage lender’s investment. And statistics show that borrowers who have more “skin in the game” are less likely to default on their loans.

By reducing the lender’s risk with a larger down payment, you could have an easier time (A) qualifying for a home loan and (B) getting a lower interest rate.

But does it make sense to put down 20% on an FHA loan?

Generally speaking, borrowers who can afford to make a down payment of 20% or more are better off using conventional mortgage loans. With an upfront investment of that size, you could avoid paying mortgage insurance entirely.

But conventional loan requirements tend to be stricter than the FHA program.

As a result, some borrowers find themselves in a situation where:

• They cannot qualify for a conventional home loan
• But they can qualify for the FHA program
• They can also afford to make a down payment of 20%

In this kind of scenario, a borrower might still benefit from putting 20% down on an FHA loan, even though it’s not required. It could help them achieve their goal of homeownership.

Benefits of Making a Bigger Down Payment

To recap: Even if you put down more than the minimum investment that’s required for an FHA loan, you’ll still have to pay for mortgage insurance. But there are some advantages of having more skin in the game.

1. Lower Monthly Payments: A larger down payment reduces the amount you have to borrow, leading to lower interest costs and a smaller monthly payment. This can free up cash for other uses or financial goals.

2. A Lower Interest Rate: Generally speaking, a larger down payment could help you qualify for a lower interest rate. That’s because interest rates are largely based on risk, and a bigger investment from the borrower reduces risk for the lender.

3. Flexibility in the Future: With more equity from the start, borrowers could enjoy more financing options down the road. This could include mortgage refinancing or using a home equity loan for renovations or other financial needs.

Five Key Points to Take Away From This

Here are the five most important points you should take away from this guide:

1. The FHA loan program requires borrowers to make a down payment of at least 3.5% of the purchase price or home value.
2. Some borrowers choose to put down more than that to reduce the size of their monthly payments.
3. FHA loans require mortgage insurance regardless of the down payment amount. 
4. With a conventional home loan, a down payment of 20% would allow you to avoid mortgage insurance.
5. Some home buyers can’t qualify for conventional financing and have to rely on the FHA program as a fallback.

Learn more: If you found this article helpful and want to learn more about the Federal Housing Administration’s mortgage program, you can download our FHA loan handbook.