Down (3.5% v. 10%) PMI, Liquidity, Gains, Taxes, Projections

[John Smith]

Have been reading forums & listening to podcast for over a year. Focused on cash flow & so on multi-families in part because of Bigger Pockets. Bought our 1st property last spring ($94,000 3-unit, using conventional mort w 25% down, with $1,650 in rents).  This might be my first question here. 

Now buying second property ($170,000 4-unit, using owner-occupied FHA mortgage). Trying to decide between FHA options, whether 3.5% down with 30 years of PMI or 10% down with only 11 years of PMI. My 11-yr projections of course favor 3.5% down, as the PMI is a push over 1st 11 years & the 3.5% down allows us to keep $11,044 in our IRA & make gains over that period. Now, my 30-yr projection of course favor 10% down, as eliminating 19 years of PMI plus the possibility of making gains on those savings is huge. However, due to the gains made by leaving money in our IRA initially & avoiding taxes on IRA withdrawal, the 3.5% down option is far more competitive than expected, in terms of a basic projection. And when I consider liquidity, the possibility of a refi, the possibility of high inflation, the possibility PMI will remain tax deductible, & such, it seems the 3.5% option is slightly superior. I am especially attracted to the liquidity advantage.

Any advice regarding my assumptions, calculations, or reasonings will be appreciated. Thanks!  

Price: $169,900

Interest rate: 3.75%

PMI: $115 per month

Down 3.5%: $5,947

Down 10%: $16,990

Taxes to be paid on IRA withdrawal required to cover 10% down, assuming 25% tax rate: $2,761

PMI over 11 years: $15,180

PMI over 30 years: $41,400

Gains assumed to be 5% annually (e.g. money left in IRA, money saved by avoiding tax penalty, money saved by not paying PMI)

*Have not factored in inflation, taxes beyond the initial taxes paid on IRA withdrawal, or the penalty on IRA home-buying withdrawal over the $10,000 allowance.

*If PMI is tax deductible over life a mortgage, then 3.5% will perform better, but there is no way to know whether it will retain its status.

Projection (11-yr) = 3.5% down beating 10% down by $18,066

Projection (30-yr) = 10% down beating 3.5% down by $28,864

[Dan Schwartz]

@John Smith looks like you have two great purchases lined up.

I would go with the 3.5% down:
1) paying the 25% withdrawal penalty doesn't seem to be an efficient use of capital.
2) when factoring in the MIP, you have a loan with an effective annual interest rate of 4.60%. That's still a great rate for an investment property, especially with that little down.
3) the sum of MIP payments in years 12-30 - if you even hold the property that long - are about $26,000. Months 133-360 of the $11,000 left in the IRA assuming an annual growth rate of 5% yield $30,000. So,
a) if you hold the mortgage (3.5% down) for 30 years, you still come out ahead on balance by leaving the $11k in your IRA
b) if you retire the mortgage (3.5% down) at any time, you will come out ahead
c) if you take the 10% mortgage and don't hold it for all 30 years, you will definitely have lost on the transaction - ignoring the possibility of loss of value in your IRA account.

My question is, "is MIP deductible on Schedule E?" I know it is on Schedule A if your AGI is below a certain threshold. But I do not know about Schedule E.

If it IS deductible, I would go ahead as above.

If it ISN'T deductible, I would look at a 5% down conventional mortgage with prepaid MI buyout. The buyout is approximately the same as the upfront MIP for FHA, but FHA allows the upfront MIP to be rolled into the loan. You would need an extra 1.5% down payment and maybe 2.0% for the MI buyout. It depends on credit score and other factors, as does the conventional loan itself. But 3.5% additional < 6.5% additional. I would only look at this if MIP is not deductible on Schedule E.

Check everything with loan officers. I am not a loan officer.