FHA with 15% Down or Conventional with 25% Down?

Question

I'm in contract to buying a 4-plex in Oakland for 1.1 M. I plan to owner-occupy one unit and rent out the other three.  I wanted to take out an FHA loan while putting just 3.5% down, but due to FHA's self-sufficiency test, I need to put down at least 15% down (said my loan officer). Here are the two options that I'm deciding between:

• A: FHA 30-yr fixed @ 2.25%/yr with ~1.00% (~$760/mo) MIP (for first 11 yrs) and ~1.75% (16K) UFMIP, and requires 15% (165K) down

• B: Conventional 30-yr fixed @ 2.75%/yr with no MIP or PMI, but requires 25% (275K) down

- I like A because I can have a bigger cash reserve while shorting a more US dollars.

- I like B because there's no PMI, MIP, or UFMIP.

- Btw, I have limited cash for the down payment and the seller is not interested in financing.

As a buyer, would you prefer A or B? And why?

Aaron W. · Answer

@David Lao Congrats on going under contract on your property.

How does the FHA and Conventional loan affect your overall cash flow? What are the monthly mortgage payments for each option?

It sounds like you may have answered your question by saying you have limited cash for down payment.

Good luck!

Will Fraser · Answer

Yeah man, you're totally right about the Refi scenario.  Once I hit 72% LTV I'd refinance onto a conventional loan if the rates allowed.  72% specifically to allow me to loan the loan costs into the loan so I'm not bringing any cash to the refi party.

Will Fraser · Answer

Hi @David Lao, since you mentioned shorting the dollar I'm going to take a leap here and say that the FHA loan is the one for you.  For starters, it's assumable.  This means that if you're holding this less-than-inflation interest rate loan on the property in 10-20 years and the dollar has done what it seems likely to do, if the market has risen above your purchase price then you'll be able to offer an assumable loan as a portion of the financing piece to the would-be buyer . .  creating a boon for them in the financing puzzle you're learning to play right now.

Another possibility here is that you'll be able to refinance off the FHA loan in the shorter term if/when you can an additional 10% equity, making the long term nature of the MIP irrelevant.

I try to view the Cash to Close and the total monthly loan payment as my two guiding lights and not care about what the labels on the dollars in the two categories go to.  For me, when I bought my 4-plex the FHA loan required less cash to close and was about $20 less per month than the conventional loan option.  Decision made!  Doesn't really matter to me if the government passes the pie around to 3,000,000 different line items, it's still cheaper debt.

David Lao · Answer

Thanks Will for your valued insights. Good point about the FHA loan being assumable. I definitely didn't factor that in. The Cash to Close is the very reason why I wanted to go with FHA in the first place -- I was hoping to just put 3.5% down. As it nears 25%, it becomes less enticing compared to a conventional loan. I really wish my decision is as clear as yours!  In my case, the FHA monthly payment (PITI+MIP) is higher than the conventional monthly payment -- by about $900/mo. I included specific numbers in my response to AJ.

Also, could you elaborate on how the MIP becomes irrelevant after a refi? I assume I'd need to refi into a conventional loan since it seems that all FHA loans have MIPs and for at least 11 years... at least in 2021. My concern is that by the time I have 10% more equity, the interest rates would have risen above today's low levels. Reference: https://www.fha.com/fha_requir...

David Lao · Answer

Thanks AJ for your valued insights. I'm definitely tempted to go with the FHA loan because of the reduced down payment. 120K is a lot, but at some point the FHA loses its advantage as it approaches 75% LTV, in which case I would go with conventional without the MIP and UFMIP.

I would be negatively cash flowing for as long as I live in the 4-plex, but after moving out, I expect to net -$360/mo on the FHA loan (85% LTV + PMI) and +$560/mo on the conventional loan (75% LTV + no MIP). I'm not super worried about the cash flow since I'm not remotely close to retiring. I'm also netting +$2K/mo. off my other rentals, which makes me less worried from a cash flow perspective.Although the FHA loan has a lower interest rate (2.25% vs. conventional's 2.75%), the FHA loan has a higher monthly payment in all scenarios due to the 1.00%/yr MIP:

• 1. FHA with 15% Down vs Conventional with 25% Down:

• - FHA: $3608+$773=$4381 (principal, interest, and MIP)
• - Conventional: $3456 (principal + interest only)

• 2. FHA with 25% Down vs Conventional with 25% Down:
•

• - FHA: $3203+$686= $3889 (principal + interest + MIP)
• - Conventional: $3456

To me, the MIP is like an extra +1.00% INT rate that it goes away after 11 years (or after refinancing out of it). So, the FHA loan is like a 3.25% INT rate loan (with 16K of UPMIP) that reverts to 2.25% after 11 years. The FHA loan will cost more per month due to the MIP. With the conventional loan, I'd have an additional ~$120K of usable cash.

FHA with 15% Down or Conventional with 25% Down?

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