0% down with 2.75% fee vs. 3.5% FHA loan - what's best?
IT Security Consultant · Seattle, WA · Member since 2015 · 30 posts · 6 votes
In searching for financing options that set me up to purchase a PR to rent later OR purchase a REI later, 2 viable options right now are:
-0% down, with no PMI, but with fees of 1.75%, 1% and normal closing costs
-FHA 3.5% down witht PMI and normal closing costs
If my goal is to put as little more down to save cash for the future purchase of another property, how do I determine which financing option will help me keep the most money in my pocket while allowing me to afford the REI property down the road?
Thanks in advance!
Are all other comparisons between the 2 loans equal? In other words, same terms, same loan lengths, same interest rates? If so and the only difference between the two loans is the down payment and fee terms, I'd approach it like this:
I have no idea what loan amount you're looking at but let's use $100,000 since it is a nice round number and helpful for easily calculating some numbers.
With option 1, you pay 0% down but you are paying 2.75% in additional fees that you would not have with option 2. So with this option you are paying $2,750 none of which contributes even a penny to your equity in the home.
With option 2, you pay 3.5% or $3500 but every single penny of that counts towards your equity in the home.
If you look at it this way, you are out of pocket an additional $750 by choosing option 2 instead of option 1 but now have $3500 of equity in your home instead of $0.
The tricky part is that option 2 forces you to pay PMI which you do not have to pay with option 1. Your challenge is to figure out what that extra monthly PMI cost will be and how quickly that eats away at the equity difference. As I understand it, 2 mortgage insurance premiums are charged on FHA loans (a 1.75% upfront premium and an annual premium paid monthly that is right around .8% depending on the length of the loan). And remember that PMI premiums are dead fees just like that upfront fee you pay with option 1. You pay the money and it contributes nothing towards your equity. That money simply dies. On your $100,000 loan, these PMI premiums amount to $1750 upfront and then an additional $800 per year which eats away very quickly at any benefit you achieved by avoiding that original 2.75% fee in option 1. The longer you hold this loan, the worse option 2 becomes.
Hope this helps.
Are all other comparisons between the 2 loans equal? In other words, same terms, same loan lengths, same interest rates? If so and the only difference between the two loans is the down payment and fee terms, I'd approach it like this:
I have no idea what loan amount you're looking at but let's use $100,000 since it is a nice round number and helpful for easily calculating some numbers.
With option 1, you pay 0% down but you are paying 2.75% in additional fees that you would not have with option 2. So with this option you are paying $2,750 none of which contributes even a penny to your equity in the home.
With option 2, you pay 3.5% or $3500 but every single penny of that counts towards your equity in the home.
If you look at it this way, you are out of pocket an additional $750 by choosing option 2 instead of option 1 but now have $3500 of equity in your home instead of $0.
The tricky part is that option 2 forces you to pay PMI which you do not have to pay with option 1. Your challenge is to figure out what that extra monthly PMI cost will be and how quickly that eats away at the equity difference. As I understand it, 2 mortgage insurance premiums are charged on FHA loans (a 1.75% upfront premium and an annual premium paid monthly that is right around .8% depending on the length of the loan). And remember that PMI premiums are dead fees just like that upfront fee you pay with option 1. You pay the money and it contributes nothing towards your equity. That money simply dies. On your $100,000 loan, these PMI premiums amount to $1750 upfront and then an additional $800 per year which eats away very quickly at any benefit you achieved by avoiding that original 2.75% fee in option 1. The longer you hold this loan, the worse option 2 becomes.
Hope this helps.
Drew,
Thanks for the quick response and perspective on the 2 mortgage options. To clarify, the mortgage terms are 30 yr and roughly the same interest rate (+/-.25%).
You last sentence is impactful on my desired outcome, which is buying and holding the PR, then turning the property into a rental. Like you say, if the loans had the same rate, term, then the key difference is the jump start in equity in scenario 2 over the lower downpayment or intial output of scenario 1.
I've been looking into what it takes to purchase the second property down the road, whether REI or the next PR, and heard that owner equity no longer plays a role in determining whether you can qualify for the next mortgage. It looks like DTI ratio has to be at 45%.
If this is true, then my strategy is to hold onto as much cash as possible in order to afford the 2nd property, and rent the first. If this strategy holds any water then I'm happy. If not, I'm back to the drawing board.
Thanks again for the thoughtful conversation.
Nick
I am guessing you are comparing VA & FHA loans.
* VA loan - How are you coming up with the 1.75% + 1%? VA funding fee does not have two components.
* FHA loan - Keep in mind that FHA also has a 1.75% upfront funding fee.
So the true comparison is:
* VA - 0% down, 2.15% funding fee, NO PMI (I am assuming you are not exempt) Your funding fee can go down to 1.5% if you do 5% down payment.
* FHA - 3.5% down, 1.75% funding fee, 0.85% MIP
Between VA & FHA, VA is the better choice.
Upen Patel, Mortgage Banker
Federal NMLS# 1374243
If the first loan is VA, then that means no PMI. I think all other traditional loans charge PMI if you have less than 20% equity. For the numbers that @Drew McLaren gave you, you get $3500 in equity from FHA, but nothing from the other. If your PMI is $70/month, then that means in 4 years the other loan becomes more attractive. Of course, you are looking for the most cash to continue investing...
I consider your FHA (particularly if you do not have VA) to be your BIG GUN for house hacking and free living. If you are buying a SFR with it you can think better. Try and get as many units as you can (up to 4) with the FHA so that everyone else is paying everything. That's the best way to be able to save fast.
If you have access to VA as well, get your 4 unit under one of them, then a year later get another 4 unit under the other. BIG GUNS! You would then have 7 doors in 2 years with excruciatingly little invested. At that point, you should be cash flowing like crazy and then you start acquiring more or snowballing payoffs, whatever your long term strategy dictates.
If you don't like 2-4 units, then I would hold on to that FHA loan for later. I don't like the idea that you can't drop PMI down the road anymore and by the time you can refinance out of it, interest rates may be pretty high. Lots of ideas, strategies, and preferences. Ultimately, there isn't enough information to decide anything.