The Low Down Payment Mortgage Trap

Low Down Payment Mortgage Loans such as FHA, USDA, VA or any type of loan where you can make a down payment of 5% or less is basically a trap. It’s a trap that leaves the borrower “under-water”, even in a good market.

Watch out, it's a trap!!! © Domas Balys -

The primary difference is that in a good market, when prices are appreciating at a steady rate of 5% per year, you don’t notice the trap because it takes less time and effort to escape from it.

But today, with housing prices flat and still eroding in many markets, the trap is much more noticeable, and more difficult to escape from unless you make a superior effort to do so.

Home prices are so low in most markets that it is indeed a great time to buy a home. The key lies in how you choose to finance your purchase. It’s the loan costs that leave the home owner owing more than the property is worth. And low-down-payment-loans are the most expensive of the so called “affordable home loans”. So expensive in fact that if you purchase your home with 5% down and a 30 year term at the historically low rate of 6%, you’ll pay about $250,000 for a $100,000 home by the time you’ve paid off your mortgage. And that’s just principal and interest, plus loan fees. We haven’t even included taxes and insurance in that total.

When you look at this fact, you realize that all borrowers who use these types of loans are instantly “under-water” from day one. You’ve just agreed to pay $250,000 for a $100,000 house. Even if it triples in value over the next 30 years, you’re not making a profit!

Today houses really are a great buy, but buying them with government insured, low-down-payment-loans could mean you’ll be paying on your home for 10 years or longer before the value of your home will be higher than the amount you owe on your mortgage. (i.e. before you have any equity at all) If you needed to sell in less than 10 years, you could have a problem selling for enough to pay off the loan.

As a real estate licensee, I am well aware of the “tenet of faith” that most home buyers must have a low-down-payment-loan in order to buy a home. But this ignores the simple fact that these types of loans are very expensive and come with fees that can add tens of thousands of dollars to the cost of an “affordable” home.

In fact, I think that licensees would do themselves a big favor by helping their buyers understand how to save as much money on that new mortgage as possible, so that they can buy a bigger house later on. This would help the licensee’s business as well.

But for some reason, most licensees never discuss this with their buyers. Buyers are left to fend for themselves once the deal is closed and the papers are signed. And often, buyers are encouraged to borrow the maximum they qualify for, not what they can comfortably afford, making it harder to make extra payments on the loan balance.

So What’s A Buyer To Do If All They Have Is 5% Down Or Less?

The smartest strategy for buyers who must utilize expensive “government insured” loans with low down payment requirements is this:

Buy a home with a comfortable payment level, then pay an additional $50 to $100 per month over and above the regular payment, to pay down the principal faster. If you do this from the very first mortgage payment, you can easily cut your 30 year loan down to 15 years or less. This is because you are paying down the principal directly. When you do this, you avoid the interest that would have been charged.

Interest is amortized in a mortgage loan. During the first ten years of your mortgage, the lender charges much more for interest. You are paying mostly interest those first ten years.

Paying an additional amount on the principal is the only way to avoid all that interest. When you do this, you are drastically reducing the total cost of your low-down-payment-loan. Your loan balance will go down much faster, your fees will be reduced much faster, you’ll build equity much faster and you’ll avoid the risk of being “under-water”. Plus, you’ll pay for your home years earlier. Then keep that equity because there is nothing more important for most ordinary folks that having a roof over your head that is paid for. Gambling is for gamblers. Equity is for home owners.

Here’s a handy link to a mortgage amortization calculator with a prepayment function you can use to help you reduce your loan costs.

So don’t be afraid to take advantage of today’s low housing prices, and if you need to, take advantage of that government insured loan program. Just plan to pre-pay a bit of your principal every month. If buyers had been educated to do this years ago, we could have avoided the housing crisis.

And now that you know this little fact, you are positioned to take advantage of today’s low prices and cheap interest rates, and make a much better deal out of it to boot. It’s a fast track to building wealth that is very practical and smart in any market. ***
Donna S. Robinson is a 16 year veteran of the real estate industry and a residential market analyst. She also has an extensive background in residential real estate investing. Get her free newsletter on her website at