Which loan to choose (less down/pay more, OR more down/pay less)?

6 Replies

Just want to talk out a situation.

  1. We are moving to a new area
  2. Have not sold current house and will operate as short term rental, $1600 mortgage plus operating expenses
  3. Under contract for a new house in new location at $123,000 (seller pays $1,500 buyers closing costs)
  4. Appraised at $127,000
  5. University town, 1 mile from campus
  6. Will live in for a year or two
  7. After move out, rent for $1000 month, maybe $1200 
  8. Disabled Veteran (do not have to pay VA funding fee)

A few loan options available that we need to make a decision on this week. I want to leave our cash available for future investments/projects but highly enticed by the low interest rate and no PMI of either VA option:

  1. VA 15yr, 2.875%, no PMI, 25% down payment required of $30,750 (25% of liquid cash available), plus closing costs, payment $832, total interest of $21,000.
    1. Advantages
      1. 2.875% interest
      2. No PMI
      3. Pay down loan quickly
      4. Less fees
    2. Disadvantages
      1. Large down payment of $30,750 (25% of liquid cash)
  2. VA 30yr, 3.25%, no PMI, 25% down payment required of $30,750, plus closing costs, payment $601, total interest of $52,000.
    1. Advantages
      1. 2.875% interest
      2. No PMI
      3. Pay down loan quickly
      4. Cash flows much better
    2. Disadvantages
      1. Large down payment of $30,750 (25% of liquid cash)
  3. Conventional, 30yr, 3.875%, PMI of ~$40 month, only 5% down payment required of $6,150, plus closing costs, payment $789, total interest of $95,000.
    1. Advantages
      1. Do not have to put as much money down and can stay liquid to use for other investments
      2. Cash flows a little better than VA 15yr
    2. Disadvantages
      1. Larger interest rate
      2. Pay PMI
      3. Finance larger amount
      4. Most of payment goes to interest
      5. Pay more interest over long run

I get asked this question/scenario a lot by friends and family.  Here's what I'll say.

Right now we have historically low interest rates.  I would be shocked if any of us were to see anything close to these low rates in our lifetimes again.  So being able to borrow the most amount of money at a low rate is probably the best long term scenario.

BUT.

That is primarily contingent on you being able to put that money to work and earn a higher interest rate than what you are paying.  Put another way.  If you are paying 3.87% then saving the $24kish in down payment is only really worth it if you put that money to work and earn more than 3.875%.  Otherwise you are just borrowing more money with no real benefit.  

The opposite scenario is to consider that if you take the higher interest rate and put the money in a savings account earning 1% per year then you are actually losing money.  You could've reduced your payment by the 2.25% spread the low yield savings account is getting you.  

If you are able to put that money to work, then the equation shifts to, are you now making more in the spread to justify the lowered peace of mind a smaller monthly payment provides.  And that's a question only you can answer depending on your personal financial and job situation.  

How's your savings account look, for me I'd rather have the cash to do with what I want vs lower payment and equity in my primary home. I say this because I can't do much with that equity.... unless I get rid of the home I'm living in which kind of defeats the purpose.

@Everett Fujii

Okay, we got the interest rate on the 30yr conventional to 3.75% and the mortgage insurance to $32.  I think this makes more sense to take a little higher interest rate and pay the nominal MI to only put down $6,150, compared to $30,750. Then we can use those funds for future projects and opportunities along with our other dedicated funds. Plus this puts the property into position to cash flow in the event we move out and rent it.

@Matt K.

I feel the same way about preservation of capital.  It doesn't make much sense for us to put cash into a house to only attempt to refi it back out and pay interest and fees on it, but the lender was sure willing to help us do that!

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