Mortgage scenario question... Comparing two loans, FHA with 5% down or conventional with 20% down. What makes the most sense?
November 16, 2011 10:53 AM Subscribe
Mortgage scenario question... Comparing two loans, FHA with 5% down or conventional with 20% down. What makes the most sense?
I am purchasing a home and am in a quandary. I have two basic loan options.
I can get a 5% down FHA loan, which comes with a 3.75% interest rate. All the costs associated with FHA (upfront MI (~4000) + monthly MI (~350 a month) add up to quite a bit. I cannot remove monthly MI costs for 5 years, which is a rule of FHA loans.
On the other hand, I can afford a 20% down loan, which would come with a conventional 4.25-4.375% which does not have those high cost Mortgage insurance costs. Conventional wisdom says pay 20% down on a house, however at 20% down, I basically break the bank and do not have any more savings, no buffer. And the rate is significantly higher on the conventional loan.
My advisor thinks that I should go with the FHA, as having cash on hand is important with the current economy. I am leaning to agree, but its so hard to go against that conventional 20% wisdom that you here all your life. I could really use an alternative viewpoint if the 20% down truly is the best option. Is it?
I am purchasing a home and am in a quandary. I have two basic loan options.
I can get a 5% down FHA loan, which comes with a 3.75% interest rate. All the costs associated with FHA (upfront MI (~4000) + monthly MI (~350 a month) add up to quite a bit. I cannot remove monthly MI costs for 5 years, which is a rule of FHA loans.
On the other hand, I can afford a 20% down loan, which would come with a conventional 4.25-4.375% which does not have those high cost Mortgage insurance costs. Conventional wisdom says pay 20% down on a house, however at 20% down, I basically break the bank and do not have any more savings, no buffer. And the rate is significantly higher on the conventional loan.
My advisor thinks that I should go with the FHA, as having cash on hand is important with the current economy. I am leaning to agree, but its so hard to go against that conventional 20% wisdom that you here all your life. I could really use an alternative viewpoint if the 20% down truly is the best option. Is it?
at 20% down, I basically break the bank and do not have any more savings, no buffer
I would caution against this, then. Buying a house always costs more than you think. Moving costs, utility activation fees, repairs, redecorating, etc. You need to have some substantial savings left after buying the house in order to take care of those unexpected costs, to say nothing of having a buffer in case you lose your job or have some other major expense come up.
posted by jedicus at 11:02 AM on November 16, 2011 [3 favorites]
I would caution against this, then. Buying a house always costs more than you think. Moving costs, utility activation fees, repairs, redecorating, etc. You need to have some substantial savings left after buying the house in order to take care of those unexpected costs, to say nothing of having a buffer in case you lose your job or have some other major expense come up.
posted by jedicus at 11:02 AM on November 16, 2011 [3 favorites]
What is the cost of the house? It is not possible to compare these scenarios financially without that information. What are the terms of the mortgages?
posted by ssg at 11:05 AM on November 16, 2011
posted by ssg at 11:05 AM on November 16, 2011
You might be able to sort of split the difference here. The FHA requires you to put at least 5% down. Is there a reason you couldn't put, say, 10% down? That wouldn't make your PMI period go down, but it might well reduce the premium involved, both up front and monthly. You could wind up saving both on interest and on PMI.
The other thing to think about is that the traditional mortgage has you putting more money in up front and paying an extra 0.5-0.625% in interest. That's not chump change. You wind up paying almost exactly the same amount of interest over the life of the loan.
posted by valkyryn at 11:07 AM on November 16, 2011
The other thing to think about is that the traditional mortgage has you putting more money in up front and paying an extra 0.5-0.625% in interest. That's not chump change. You wind up paying almost exactly the same amount of interest over the life of the loan.
posted by valkyryn at 11:07 AM on November 16, 2011
Response by poster: The home is in the mid 400s, which is average for my area. As for the 20% breaking the bank, That would include a conservative budget for moving/closing/utility hook up/etc. Basically, I would be in the house and ready to go, but would not have a savings beyond that. Decorating the new pad would be a slower process, as I would need to save up more cash.
I don't think PMI goes down if you pay more then 5%. There is a slight increase if you do less then 5%, which is why I was targetting that number, and not the minimum 3.5% down.
posted by ShootTheMoon at 11:12 AM on November 16, 2011
I don't think PMI goes down if you pay more then 5%. There is a slight increase if you do less then 5%, which is why I was targetting that number, and not the minimum 3.5% down.
posted by ShootTheMoon at 11:12 AM on November 16, 2011
The following does not consider that the more you pay down, the less liquid you are, but the less you pay over the life of the loan. This is basic, and fundamental.
Now: PMI is typically applied when the total amount of money borrowed exceeds the conforming loan limit; in theory, if you pay down the FHA loan with 20% instead of 5%, the amount would fall under the conforming loan limit (just as it does with the conventional loan.) "I don't think" is not how your answer should start for such an important question, so reach out to your advisor/lender ASAP to see what options are.
The FHA offers a lower interest rate: good. It also lets you maintain more liquidity: good. However, it imposes a significant cost beyond the principal and insurance: bad.
The conventional offers a higher interest rate: bad. It also removes your liquidity: bad. However, it does not impose a significant cost beyond the principal and insurance: good.
In theory, the FHA paid down more than 5% but less than 20% would offer a lower interest rate: good. It also lets you maintain some liquidity: good. If I am correct, it also does not impose a significant cost beyond the principal and insurance: good.
So go find out if that is an option.
posted by davejay at 11:19 AM on November 16, 2011
Now: PMI is typically applied when the total amount of money borrowed exceeds the conforming loan limit; in theory, if you pay down the FHA loan with 20% instead of 5%, the amount would fall under the conforming loan limit (just as it does with the conventional loan.) "I don't think" is not how your answer should start for such an important question, so reach out to your advisor/lender ASAP to see what options are.
The FHA offers a lower interest rate: good. It also lets you maintain more liquidity: good. However, it imposes a significant cost beyond the principal and insurance: bad.
The conventional offers a higher interest rate: bad. It also removes your liquidity: bad. However, it does not impose a significant cost beyond the principal and insurance: good.
In theory, the FHA paid down more than 5% but less than 20% would offer a lower interest rate: good. It also lets you maintain some liquidity: good. If I am correct, it also does not impose a significant cost beyond the principal and insurance: good.
So go find out if that is an option.
posted by davejay at 11:19 AM on November 16, 2011
Response by poster: Thanks davejay. Just to confirm, the PMI monthly cost is a fixed percentage of the total money borrowed. So, putting more down would decrease that monthly cost. I am going to review this further to see how much would be saved on the MI at putting 10% down. However, putting more down does not affect the interest rate. 3.75% is a great rate, and is fixed at whatever I put down on the home.
posted by ShootTheMoon at 11:30 AM on November 16, 2011
posted by ShootTheMoon at 11:30 AM on November 16, 2011
And the rate is significantly higher on the conventional loan
There may be other important details involved, but it's very unlikely that you would actually save money due to the lower FHA rate. For the FHA loan you have $4000 upfront plus $350*12*5, which combined is around $25,000 , and on top of that your loan will be for a higher amount so the effective amount you are paying in interest is higher. With a $400,000 home, 3.75% on a $380,000 loan would be $14,250, whereas 4.375% on a $320,000 loan would actually be slightly less at $14,000. Even if both loans were for the full amount of $400,000, the less than 1% difference in rates would only result in a total savings of $2,500 for the first year, so it would take quite a while for the difference in rates to outweigh the extra costs for the FHA loan.
however at 20% down, I basically break the bank and do not have any more savings, no buffer
This is not really good either. But realize with the 5% down loan, you have basically no buffer between your loan amount and the value of the home. If prices drop significantly over the next few years, you might end up far enough underwater that you will not be able to sell if you end up needing to. The best thing to do would be to wait until you have enough for both the down payment and emergency savings. Overall if you go with the FHA loan you are paying to reduce risk related to emergency savings, at the cost of significant fees and increased risk on exposure to housing prices.
posted by burnmp3s at 11:30 AM on November 16, 2011
There may be other important details involved, but it's very unlikely that you would actually save money due to the lower FHA rate. For the FHA loan you have $4000 upfront plus $350*12*5, which combined is around $25,000 , and on top of that your loan will be for a higher amount so the effective amount you are paying in interest is higher. With a $400,000 home, 3.75% on a $380,000 loan would be $14,250, whereas 4.375% on a $320,000 loan would actually be slightly less at $14,000. Even if both loans were for the full amount of $400,000, the less than 1% difference in rates would only result in a total savings of $2,500 for the first year, so it would take quite a while for the difference in rates to outweigh the extra costs for the FHA loan.
however at 20% down, I basically break the bank and do not have any more savings, no buffer
This is not really good either. But realize with the 5% down loan, you have basically no buffer between your loan amount and the value of the home. If prices drop significantly over the next few years, you might end up far enough underwater that you will not be able to sell if you end up needing to. The best thing to do would be to wait until you have enough for both the down payment and emergency savings. Overall if you go with the FHA loan you are paying to reduce risk related to emergency savings, at the cost of significant fees and increased risk on exposure to housing prices.
posted by burnmp3s at 11:30 AM on November 16, 2011
You should see if you can calculate the interest rate when you include five years worth of monthly PMI payments. It's a little bit more difficult because the PMI payments don't continue for the life of the loan. You basically want to calculate the APR (a rate the reflects the total cost of the loan including PMI).
The other way to look at it is to figure out how much in interest and fees you'll end up paying over the course of however long you think it will be before you buy a different house (or pay off the loan, whichever comes first). That will give you a better idea of how much each loan costs.
Some quick and dirty calculations suggest that putting 20% down will lower your monthly payment by about $550 ($200 from a lower principle amount despite the higher rate and $350 from PMI). How long would it take you build your saving back up with an extra $550/month plus whatever else your budget will allow?
You could also put 20% down and take out a home equity line of credit to cover you until you can build your savings back up. Many banks will allow up to a 90% combined loan to value ratio so, on a house worth $450,000 with a $360,000 mortgage, you could have a $45,000 line of credit that wouldn't cost you anything unless you use it and you almost certainly won't need to use it.
It isn't really that different from keeping more cash in the bank and putting 5% down. It's just a different way of hedging against your future cash needs.
I would assume that your mortgage adviser has already done this but there are sometimes state, county, or city programs for first time home buyers that could be a better deal than either of those options.
posted by VTX at 11:41 AM on November 16, 2011 [3 favorites]
The other way to look at it is to figure out how much in interest and fees you'll end up paying over the course of however long you think it will be before you buy a different house (or pay off the loan, whichever comes first). That will give you a better idea of how much each loan costs.
Some quick and dirty calculations suggest that putting 20% down will lower your monthly payment by about $550 ($200 from a lower principle amount despite the higher rate and $350 from PMI). How long would it take you build your saving back up with an extra $550/month plus whatever else your budget will allow?
You could also put 20% down and take out a home equity line of credit to cover you until you can build your savings back up. Many banks will allow up to a 90% combined loan to value ratio so, on a house worth $450,000 with a $360,000 mortgage, you could have a $45,000 line of credit that wouldn't cost you anything unless you use it and you almost certainly won't need to use it.
It isn't really that different from keeping more cash in the bank and putting 5% down. It's just a different way of hedging against your future cash needs.
I would assume that your mortgage adviser has already done this but there are sometimes state, county, or city programs for first time home buyers that could be a better deal than either of those options.
posted by VTX at 11:41 AM on November 16, 2011 [3 favorites]
Another part about the PMI: you will need to pay it for a set term (in this case 5 years, yikes) and then you can *apply* to have it removed. But that only will be approved if at that time your loan amount is 80% or less of the market value of the house. Look carefully at the amortization table for that FHA loan and see if you get even close to 80% LTV in 5 years... Assuming the house retains its present market value, which may not be a safe assumption.
I'd take the conventional with 20% down just on that fact alone. If that transaction leaves you with no cash at all, but also healthy ( read unused but available) lines of credit AND enough room in a realistic budget to start saving again (and/or beating back newly accrued credit debt) then I think that's the better choice.
posted by Sublimity at 11:53 AM on November 16, 2011
I'd take the conventional with 20% down just on that fact alone. If that transaction leaves you with no cash at all, but also healthy ( read unused but available) lines of credit AND enough room in a realistic budget to start saving again (and/or beating back newly accrued credit debt) then I think that's the better choice.
posted by Sublimity at 11:53 AM on November 16, 2011
The FHA is also a fixed rate mortgage, right? Or is it one of the new 1/1/5 capped ARMs?
posted by misha at 12:19 PM on November 16, 2011
posted by misha at 12:19 PM on November 16, 2011
Sorry, just saw this "3.75% is a great rate, and is fixed at whatever I put down on the home."
posted by misha at 12:56 PM on November 16, 2011
posted by misha at 12:56 PM on November 16, 2011
burnmp3s: " The best thing to do would be to wait until you have enough for both the down payment and emergency savings. Overall if you go with the FHA loan you are paying to reduce risk related to emergency savings, at the cost of significant fees and increased risk on exposure to housing prices."
I know this isn't what you want to hear, but burnmp3 has this right. And I'll also second the "buying a house always costs more than you think it will."
Nearly always, the 20% is going to be best. Paying PMI is a waste of your money, and the upfront costs on the FHA are surprisingly high (upfront MI of 10%+ seems high to me, anyway).
But if you spend all your savings on a 20% down payment and have no emergency fund, you are setting yourself up for trouble. Something always ends up costing more--you need basic window coverings and the windows are all non-standard sizes, or your water heat goes, or your washing machine overflows and you have to buy a new one and maybe have the floor redone, too--and that's just with the house. What if you get sick and have expensive medical bills? What if you get laid off?
Also, closing costs estimates are just that. Of all the people I know, I can count on one hand with four fingers chopped off the families who got a check *back* at closing because the estimate was high (it was us, and my SIL was the mortgage loan officer). 99% of the time, you are going to pay more at closing than the estimate.
As a general rule of thumb, if you plan to put 20% down on a home, I would recommend that you have enough for at least 6 months worth of mortgage payments in additional savings for emergencies.
So if you absolutely, positively must have this house--the deal is great, it's worth a lot more, you won't find another like it at this price in a hundred years--and 20% would break the bank, my advice would be to go for the FHA, but put down ~15% and keep what's left for your Emergency Fund.
posted by misha at 1:53 PM on November 16, 2011
I know this isn't what you want to hear, but burnmp3 has this right. And I'll also second the "buying a house always costs more than you think it will."
Nearly always, the 20% is going to be best. Paying PMI is a waste of your money, and the upfront costs on the FHA are surprisingly high (upfront MI of 10%+ seems high to me, anyway).
But if you spend all your savings on a 20% down payment and have no emergency fund, you are setting yourself up for trouble. Something always ends up costing more--you need basic window coverings and the windows are all non-standard sizes, or your water heat goes, or your washing machine overflows and you have to buy a new one and maybe have the floor redone, too--and that's just with the house. What if you get sick and have expensive medical bills? What if you get laid off?
Also, closing costs estimates are just that. Of all the people I know, I can count on one hand with four fingers chopped off the families who got a check *back* at closing because the estimate was high (it was us, and my SIL was the mortgage loan officer). 99% of the time, you are going to pay more at closing than the estimate.
As a general rule of thumb, if you plan to put 20% down on a home, I would recommend that you have enough for at least 6 months worth of mortgage payments in additional savings for emergencies.
So if you absolutely, positively must have this house--the deal is great, it's worth a lot more, you won't find another like it at this price in a hundred years--and 20% would break the bank, my advice would be to go for the FHA, but put down ~15% and keep what's left for your Emergency Fund.
posted by misha at 1:53 PM on November 16, 2011
Just another thing to consider: even if you are eligible for an FHA loan, a lot of houses aren't because they won't pass FHA appraisal (and a good many sellers specify conventional, reno, or cash only, no FHA). I imagine this is less of an issue for $400K+ houses than houses in my price range, though.
If you're working with a buyer's agent, they should be able to give you their best guess as to whether you can get an FHA loan on the particular house you are interested in.
posted by Violet Hour at 10:05 PM on November 16, 2011
If you're working with a buyer's agent, they should be able to give you their best guess as to whether you can get an FHA loan on the particular house you are interested in.
posted by Violet Hour at 10:05 PM on November 16, 2011
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It's a great option if it doesn't break the bank. If you have the capital to spare, then I'd say put 20% down. Since you obviously don't have that kind of capital to tie up into a house, then obviously this might not be a great idea. Plenty of people don't put 20% down if they don't have the cash to spare. I didn't, and lots of people I know didn't.
However, the up front MI costs and monthly costs you were quoted sound really, really high (though maybe your house is much more expensive than mine was).
posted by deanc at 10:58 AM on November 16, 2011