Sunday, August 24, 2014

FHA loan vs. 10% Down Payment Conventional Loan vs. 20% Down Payment Conventional Loan


I would like to start getting into investment property in the future but for now I am absorbing as much information through reading books. I just finished reading the “ABCs of Real Estate Investing” and I am waiting for “Buy It, Rent It, Profit!” to come in the mail. The cost of buying an investment property varies depending on many factors. I am an absolute beginner to real estate investing but I recently developed 3 tables for what the expenses could look like for a $125,000 home in my area, assuming a 4% interest rate.  Here are the examples of the mortgage programs available to me.

FHA Loan
Expenses
Estimated Cost
Down Payment (3.5%)
$4,375
Closing Costs (3%)
$3,750
Emergency Fund (6 months of Expenses)
$8,100
Property Tax (Based on a home I looked at)
$2,578
Maintenance (2%)
$2,500
Appliances/Furnishings (Dish Washer, Oven, Microwave, Couches, etc.)
$1,750
6 Months of Mortgage (In case of emergency)
$4,236
Home Inspection (Estimate)
$200
Home Appraisal (Estimate)
$375
Attorney (Estimate)
$600
Total
$28,464
Mortgage
$706

 FHA (Federal Housing Administration)

The FHA is one of the more popular choices among first time homebuyers. It has been a great choice for those who do not have a ton of money saved since you don’t have to have a large down payment.

Advantages

  • You only need a credit score of 580 in order to qualify

  • You can qualify with a low down payment of 3.5% of the home price

  • The interest rates compare to those of a conventional loan

  • The down payment can be gifted from a family member or friend

  • You may also borrow against your 401k for a down payment

  • No prepayment penalties

Disadvantages

  • You have to pay Private Mortgage Insurance on your home

  • Private Mortgage Insurance is harder to cancel

  • PMI fee is usually higher than compared to a conventional loan

  • Some properties aren’t approved for FHA loan financing

  • Little to no instant equity

  • Higher monthly mortgage payments
 
  • Less positive cash flow or ROI (Return on Investment)


10% Down Payment Conventional Loan
Expenses
Estimated Cost
Down Payment (10%)
$12,500
Closing Costs (3%)
$3,750
Emergency Fund (6 months of Expenses)
$7,860
Property Tax (Based on a home I looked at)
$2,578
Maintenance (2%)
$2,500
Appliances/Furnishings (Dish Washer, Oven, Microwave, Couches, etc.)
$1,750
6 Months of Mortgage (In case of emergency)
$4,002
Home Inspection (Estimate)
$200
Home Appraisal (Estimate)
$375
Attorney (Estimate)
$600
Total
$36,115
Mortgage
$667

 
Conventional Loan with 10% Down Payment

This conventional loan is great for a homebuyer who has some cash on hand but doesn’t want to empty his savings account. A conventional loan adheres to the guidelines set by Freddie Mac and Fannie Mae. The federal government does not insure these types of loans.

Advantages

  • You will receive a competitive fixed interest Rate

  • The Private Mortgage Insurance fee is much less

  • Closing costs on your home our lower when compared to an FHA loan

  • You can cancel PMI once your Loan to Value reaches 80%

  • This type of loan can be used on all property

  • You can hold numerous conventional loans at a time

  • Nearly every bank offers Conventional loans so your options are open

  • Higher equity unless your house is worth less than you paid for it

Disadvantages

  • You are forced to pay Private Mortgage Insurance

  • You need a credit score of 680 or higher to qualify

  • More difficult to qualify than the FHA Mortgage program

  • There could be a prepayment penalty

  • Higher down payment

20% Down Payment Conventional Loan
Expenses
Estimated Cost
Down Payment (20%)
$25,000
Closing Costs (3%)
$3,750
Emergency Fund (6 months of Expenses)
$7,500
Property Tax (Based on a home I looked at)
$2,578
Maintenance (2%)
$2,500
Appliances/Furnishings (Dish Washer, Oven, Microwave, Couches, etc.)
$1,750
6 Months of Mortgage (In case of emergency)
$3,642
Home Inspection (Estimate)
$200
Home Appraisal (Estimate)
$375
Attorney (Estimate)
$600
Total
$45,395
Mortgage
$607

 Conventional Loan with 20% Down Payment

This program is very similar to the 10% Down Payment mortgage. This used to be the required down payment a long time ago, but these days a 20% down payment is avoidable. The same pros I mentioned for the 10% down payment type of loan also apply to this type of mortgage program. You also get a whole new list of advantages.

Advantages

  • You immediately start with a good amount of equity with 20% down

  • The closing costs are much lower and may be waived by seller

  • You are no longer require to pay a Private Mortgage Insurance

  • Lower monthly mortgage payments

  • You will receive the best-fixed interest rate

  • Smaller mortgage makes it possible to get a 15-year mortgage with lower interest rate

  • You get a better return rate and positive cash flow on your investment property

Disadvantages

A large down payment is hard to come up with
 
How do you feel about these mortgage programs? Would you add any advantages or disadvantages to any one of these loans?

 

6 comments:

  1. I think sometimes it depends on your earnings and price of the house how much you have to put down. I bought 2 houses in the past and I use same mortgage lady. she usually calculate for me how much I can afford and how much down payment I need. I usually do my calculations before I even start shopping for the house. This way I know my price range for sure.

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  2. I am hoping to go with the 20% down option, but that also depends on the price of the home. The biggest factor is whether the investment will generate positive monthly income from rentals. But I also like the fact that the 20% down gives you that instant equity. Thanks for stopping by!

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  3. I think the 20% is probably the easiest to get financing on. My parents and I are wanting to buy a rental property and banks lend easier when you have equity in the property. But then again, it's difficult to come up with 20%, especially here in California. With a lower down payment, you have a higher mortgage payment. So it really depends on your situation.

    Thanks for the post, cheers!

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  4. Hey Henry,
    I am currently leaning towards the 20% down payment option in order to give me the best return on investment. Avoiding PMI alone is worth waiting an extra year to save all that money. My original plan was to create a partnership with a friend in order to buy mutiple units bug he fell on some hard times. Going into alone involves a lot more risk. Good luck on finding a rental property anx thanks for commenting!

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  5. Hi DM,
    Was Home insurance included in the mortgage costs, otherwise it might be useful to break that cost out separately.

    Definitely avoid PMI and as you say, it's worth waiting a year to avoid that cost.
    Are you planning to do all the renting yourself or use a property management company? I thought about renting my old house but it was out of state and a big headache so buying a REIT is probably the closest I'll get to rental income.

    Best wishes,
    - DL

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  6. Hey DL,
    The home insurance was included in the mortgage costs according to the mortgage calculator I used. I am planning to manage the property because I will be living in one of the units. I'm considering a duplex so I will only have to manage two units which shouldn't be too bad. Owning REIT's are great because you don't have to worry about any headaches and/or deal with people. Thanks for stopping by!

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