3 finance options - Struggling to decide

[Jay Dean]

My wife and I are under contract to buy a home.  We plan to do a live in renovation with the intent of making it a rental (selling only as a plan B).  The future plan includes buying another home, possibly fixing it up, staying for a bit, and then making it a rental.  The process repeats.

I am a buy and hold guy.  I don't have any interest in becoming a flipper but if I see a chance to get a big payday I will take it.  I am not seeking advice trying to pull me away from buy and hold as a primary strategy.

We have been presented with three financing possibilities and I am struggling to decide.

FHA 3.5% down 3.49% interest - Required mortgage insurance is $128.74

Conventional 5% down 4.25% interest - Required mortgage insurance is $96.27

Conventional 20% down 4.25% interest - No required mortgage insurance.

We have plenty of cash for any down payment and for the renovations.

I am struggling with:

- The idea of paying mortgage insurance.  

- Having a big chunk of our money (roughly $27,000 additional dollars toward the down payment) tied up in the home. 

- Having this home financed FHA (and not being able to get a second FHA loan).

- Going with FHA knowing the only way I will get rid of the PMI is to refinance (likely at a higher interest rate).

I welcome your input.

[Chris Mason]

Always surprises people that FHA 3.5% down 680 FICO gets a better rate than Conv 20% down 800 FICO. :) Downsides are what you identify, minus bullet point #3, plus the FHA UFMIP fee that gets rolled into your loan balance.

Bullet point #3 doesn't matter because FHA, while not a FTHB only program, becomes hard to use if you already own real estate, for various reasons pertaining to when rental income can "count."

It appears that your loan amount is about $180k.

With FHA, the mortgage insurance is 0.85% if you annualize it. Add that to 3.5% and you arrive at 4.35% as your effective permanent interest rate. Plus about $3100 UFMIP rolled into your loan balance, that you don't get back (by contrast, additional down payment is money you can get back when you sell or refinance).

The conventional mortgage insurance @ 95% LTV looks like it's about 0.64%. Same math, 4.25%+.64%= 4.89% effective temporary interest rate, dropping to 4.25% once the mortgage insurance drops off. With no funding fee.

But you have the ability to do 20% down.

The sweet spot here is to call your LO and ask about Conv 10% and Conv 15% down. The smaller the gap between your down payment and 20%, the less the insurance has to cover, the cheaper it is. One of the banks I work with is at 0.1% @ 85% LTV and good credit, but prevailing market is around 0.14%.

So you'd likely be looking at 4.25%+.14% = 4.39% temporary, dropping to 4.25% permanent, with no funding fee. That might be the sweet spot. Or 10% down, perhaps. 

But I guess my point is, comparing FHA 3.5% down to Conv 20% is a bit extreme, that's like asking "do I have zero beers, or do I drink 3 bottles of wine and go to the emergency room?" like there isn't any happy middle ground between those two. Now that you are in escrow, the LO should be presenting these options, and if they don't you should ask for them. :)