Conventional 30-year Mortgage with 5% down or FHA with 5% down?

Discussion in 'Community Discussion' started by puma1552, Jul 7, 2011.

  1. puma1552 macrumors 603

    Nov 20, 2008
    So, I've heard a lot about FHA loans, ARMs, traditional mortgages, etc.

    I understand ARMs are basically terrible, and I will not do an ARM. I will only do a 30-year, fixed rate, the way things were done before the market crashed.

    But what's the consensus on FHA loans? Good, bad, neutral? Are these fairly new, and part of what contributed to the housing market crash?

    I have a 770-790 credit score, depending on bureau. I've had 5 loans through my credit union (auto/unsecured personal), and a couple credit cards, one being a Visa through said credit union. I'm 27. In other words, I have high credit due to actual good credit history and usage of credit, not just from having one credit card and never messing up (I know a lot of people with high credit scores but they just have them mainly because they've never actually utilized credit beyond maybe one credit card they rarely use).

    20% down just isn't likely going to happen. I know it's best to avoid PMI, and not be upside down on a house that potentially ends up sliding in value these days, but at this point in life 20% isn't realistic unless we drain all of our savings and then some, which we can't/won't do. So let's remove that from the current topic, as I'm only soliciting advice on the difference between FHA/conventional mortgages here, with an equal amount of money down.

    We can do 5% down on a house. In my research between the differences of FHA/conventional mortgages, I found this:

    It seems that the primary difference is the way the mortgage insurance is handled, being that you pay PMI until you get to 20% equity on a traditional mortgage, whereas with an FHA you can put only 3% down but must put down 1.5% of the home's value for insurance at closing, and then .5% annually for the entire 30 years.

    To me, it seems like the FHA loan is a bad deal, because that's a lot of money going to insurance.

    I know FHA loans are popular now because a lot of banks have cracked down and require the 20% down payment for a conventional mortgage like the old days, but let's say I can get a traditional mortgage with 5% down based on my credit score/history. In that case, is there ANY reason why I would want to take an FHA mortgage vs. a conventional mortgage?

    In other words, downpayments equal (5% in both cases), is there any reason to take an FHA mortgage over a traditional mortgage if I could be lucky enough to get a traditional mortgage with a good rate?

    My gut says no, take the traditional mortgage no matter what.

    But I've just started looking at FHAs and really am not sure what the general consensus is; I'm kind of old school, so to me anything but a traditional mortgage seems like a bad deal.
  2. Tomorrow macrumors 604


    Mar 2, 2008
    Always a day away
    FHA can get you a slightly lower interest rate vs. a conventional mortgage, but typically they won't give you as big a loan. That wasn't an issue in our case; the FHA loan was plenty for what we were willing to spend.

    We bought our house with very little down payment, but I believe it may now be the case that an FHA loan requires about 20% down - I could be way, way wrong, however, so don't count on that.

    Smart thinking to not make yourself house poor at the outset. A small down payment can work very nicely, if you can find a lender willing to go that route with you.
  3. sushi Moderator emeritus


    Jul 19, 2002
    Consider purchasing a home that keeps you from being house poor.

    The FHA recommends 29% of Gross Income or up to 41% if you have no dept. When you think about it, that is really pretty high. For example, let's say you have a house payment of $2,050, that only leaves you $2,950 for everything else (taxes, food, clothing, cars, insurance, etc.).

    David Bach, for example, recommends paying most at 1/3 of Gross Income but prefers 1/3 of Net Income. Using the same example above, at Gross Income, you could afford a home with $1,650 leaving $3,350 for everything else. That's 13.5% increase in income if you will. Looking at Net Income, your savings will be even more since your mortgage is less.

    Another thing to consider, is what happens is you loose your job, or your wife does. Best to be conservative especially in this economy.
  4. snberk103 macrumors 603

    Oct 22, 2007
    An Island in the Salish Sea
    I'm from north the border, where we do mortgages differently - so I won't try to give you advice there. However, we've owned several houses, and have experience with mortgages as a concept.

    My advice (take it or leave it)... is to start with a small house. Being "House Rich" means you are "cash-poor". Even if you have managed to get a manageable monthly payment schedule, at the end of 30 years the bank has your cash (in interest payments.) And you own a house that is now 30 years older.

    So, start smaller, put as much down as you can in the downpayment. Then, skimp and save, and at every opportunity prepay what you can on the mortgage. Anything extra you can put down in the 1st year is especially important, as the savings (to you) are then leveraged over the run of the mortgage.

    In Canada (and I assume in the US as well) prepayments (we call them privilege payments) are applied to the principle. As the principle amount decreases your monthly payments are then applied less towards the interest portion, and more towards the principle. That is, more of your budgeted payments are also being applied to the principle loan amount. Anything you put down in the 1st year then accelerates the portion of the payments towards principle in subsequent years.

    Find a good mortgage calculator, and play with some numbers - with prepayments in the first few years, and watch how much less you end up paying the banks.

    If you decide to sell the house, and payoff the mortgage, you will have lots more equity to apply to a down-payment on your next home.

    I believe we have more flexible mortgage products here, so this may not apply. We usually had our mortgage in two different types of loan. One would be a fixed rate loan, and the other a variable rate. Depending on where we thought rates were going we would concentrate our prepayments on one or the other. We've never had a mortgage for longer than a 5 year term .... though we have had several mortgages. We've moved 5 times 21 years - we now own a house that we had designed and built for us, on 10 acres of land - mortgage free for about a year now.

    Until last year our primary vehicle was a 1987 Toyota. We really shop the sales for clothes, and sometimes the thrift stores (but only for the quality stuff. My wife finds designer clothes there that have never been worn, and I shop for Hawaiian shirts. Etc etc. We don't live poor, but we made a deliberate decision to do without some luxuries (not all - I like my single malt scotch) while we paid off our mortgages. We've always travelled, but we stayed in budget hotels and go to places off-season. etc etc Lots of ways to save money.

    We are now both cash and house rich. It was worth it. And we did it by leveraging the power of prepayments (especially in the early stages) of a mortgage.

    Take my advice or leave, makes me no-never-mind..... :)
    I'm not the one making the bank rich.....
  5. rdowns macrumors Penryn


    Jul 11, 2003
    Frankly, if all you have is 5% to put down, you can't afford that house. Shaking my head that you can still get a mortgage with so little down. We never learn our lessons.
  6. puma1552, Jul 8, 2011
    Last edited: Jul 8, 2011

    puma1552 thread starter macrumors 603

    Nov 20, 2008
    Cool story bro.

    Hope the air isn't too thin to cause brain damage from up on that pedestal looking down at everyone else.

    There's a pretty big difference between having a 780+ credit score and being responsible with money and putting 5% down on a mortgage through a credit union that would still only cost us about 1/5 of our monthly gross income even after factoring in PMI and keeping a substantial amount of cash in savings, and taking the biggest mortgage any old bank will give you at any old rate regardless of what you can afford.
  7. sushi Moderator emeritus


    Jul 19, 2002
    If I understand you, you will have a PMI equal to 1/5 of your monthly income.

    Let's say you make $5,000 per month. That's means you will need to pay $1,000 which leaves you $4,000 per month.

    Out of the remainder, you will need to pay for things like:
    • Income Tax (Federal and State). (State unless exempt.)
    • Health care assuming that you had Japanese health care here in Japan.
    • Property tax. Can be huge in some cases.
    • Utilities (Electric, Gas, Water, etc.).
    • Trash collection.
    • Car. Hard to get around without one. So another payment.
    • Maybe another car?
    • Food.
    • Clothes.
    • Communication such as Cable TV / Internet / Phone / Cell phones / etc.
    • Entertainment.
    • And of course retirement planning/savings.

    This list goes on.

    Remember, when you own a home, you really don't own it. The bank does. And it will continue to do so until you provide the bank your final payment.

    You mentioned that you are 27 years old. That means for a typical 30 year loan, you will pay it off at age 57 years old.

    By putting down a deposit of 20%, you also keep yourself on the ball to keep making payments should your economic change drastically.

  8. puma1552 thread starter macrumors 603

    Nov 20, 2008
    No, what I was referring to was having the entire PITI equal to 20% of my monthly income. In other words, the entire mortgage payment, taxes, and insurance would only be 20% of the monthly income, which is plenty affordable, and much more comfortable than most banks do and most people take. Most banks allow the monthly payment to be upwards of 28% of the gross monthly income to my understanding, with a total DTI of 36% for everything (car payments, student loans, etc). We are planning on staying well below that, regardless of how large of a downpayment we make. I've got one car payment now, which is a small amount at a very low rate through my credit union which will be paid off by spring, and then my wife needs a car. So of course, I'm thinking about the whole picture here. I'm plenty able to make a budget, been doing it since I was paying my mom and mine's mortgage and all utilities at 17 years old on $8 an hour.

    The point is, we would be buying a cheap house, taking an actual mortgage that is substantially less than any bank would qualify us for.

    This isn't a thread to discuss the merits of 20% down payments or not, this thread was about the difference between an FHA and a conventional mortgage, down payments equal, and I thought I had mitigated that in the OP. Nothing more. But for whatever's sake, let's just change the example to 20% so we can move on and answer the question at hand. Like I said, I'm oldskool and prefer to do things the traditional way, so I'm wary of FHAs, but I don't know much about them or what the general consensus is. I'm just trying to learn more about them.

    20% down on an FHA vs. 20% down on a conventional mortgage, ANY reason to take an FHA?

    I appreciate the advice so far, but please let's just focus on FHA vs. conventional, all things equal.
  9. rdowns macrumors Penryn


    Jul 11, 2003

    Oh look, another one who asks for advice and can't take it when others don't agree with him. What was the point in asking? :rolleyes:

    No you don't.
  10. puma1552 thread starter macrumors 603

    Nov 20, 2008
    More like another one who can't read the OP worth a damn. What was the point in replying if you didn't answer the question that was asked? Christ. :rolleyes:

    If only you had given advice pertinent to what I was asking.
  11. sushi, Jul 9, 2011
    Last edited: Jul 9, 2011

    sushi Moderator emeritus


    Jul 19, 2002
    This seems reasonable for PITI.

    You are well below the FHA 29% of Gross Income or up to 41% if you have not dept. But we live in a Net Income world. So I would definitely remove Federal and State income tax, students loans, etc. to see your Net Income without those two.

    Also, in these days, you or your wife may end up loosing your job. Being conservative, I would plan for that when taking out a loan. Nothing live having a loan for 20% that gets bumped up to 40% (assuming you have equal jobs).

    I've had both.

    In simple terms, FHA loans provide options for first time home owners. Low downpayment is one.

    A conventional mortgage provides you more options, such as a 2nd or 3rd mortgage, sale by owner, etc. Also you can get an ARM which can increase over the time of the loan (which I wouldn't recommend unless you will pay of your mortgage early in say 5 years or less).
  12. puma1552 thread starter macrumors 603

    Nov 20, 2008
    Thanks, what did you find to be the cons of each, or which did you like better/was the better deal?
  13. sushi Moderator emeritus


    Jul 19, 2002
    When I did the FHA, I took the minimum downpayment which was nice. At the time, I got a better rate at the time. Back then, rates were much higher.

    Note, I did have the funds to pay, but wasn't sure what it would take being it was my first case of home ownership. Things like stoves, refrigerators, washers/dryers, drapes, etc. needed to be paid for as well since I bought it new.

    With conventional loans, you might assume a current loan, and them take out a 2nd one to pay off the owner. In other words, the original loan continues and you have a second on top of it to pay off the owner, or you can refinance as a 2nd loan paying off the first loan. Lot's of way's to skin a cast.

    I did sale by owner purchase. He still owns the property, but I make payments to him at his bank. If I default, it's his. We went to the bank where he does business. We drew up an account for me to pay and him to receive. We each pay a dollar for the service. I write off payments and he declares as income on his statement. Works fine.

    Home purchases can be a real drag. Your loan will last a very long time. During the early years, you pay mostly interest and not principle. For example, on $200,000 loan at 5%, after 10 years, you will still owe around $163,000 if you make no further additional payments. That's only a reduction of $37,000 debt.

    BTW, that is why bank charge interest the way that they do. They know that most people change homes/jobs around 5-7 year. This way the banks get their money! :)

    Getting back to the $200,000 loan at 5%, if you paid an additional $500.00 per month, you could pay off your mortgage in 181 payments, or about 15 years. So an extra $90,500 in extra payments would result in $191,384.70 in savings. Of course you would loose the tax write off each year after the 15th, but trust me it's better to own your own house free and clear. And the tax write offs, aren't going to equal what you payed.

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