The Down And Dirty Facts About FHA Loans
Owner-occupant home buyers do not usually think of themselves as investors who are trying to make money, so they pay full price for a home and get a government insured loan for the purchase, without giving it too much thought. Most of their focus goes into picking the right neighborhood or the right style and location. These are fundamentals that are more important to them than the money. They sort of assume that their home will eventually go up in value.
The other sector is the 20% of buyers and sellers that make up the investing market. These are sellers who sell at a discount, and buyers who buy at a discount. These buyers and sellers are consciously attempting to make a profit, and their objective is to make money or build wealth.
But I believe that all home buyers are real estate investors, for the simple reason that no one buys a home with the intention of losing money. But with government insured loans, this is usually what happens.
As a result of on-going government intervention since the great depression of the 1930’s, today’s mortgage industry has grown into a half-private, half-public money machine that has become a monster.
While government insured loans such as FHA, VA and USDA were created to help low income buyers afford a home mortgage, the result has been very expensive loans that will more than double the costs of a home loan.
Note I said the cost of the loan. Not the cost of the home. The property value is set. It’s the loan costs that go up. And few loans are more expensive than government insured loans that are supposedly designed to help low income buyers.
Most retail buyers using a traditional FHA, (government insured), mortgage to buy a home never even realize the real costs over time. Traditional mortgage loans can be very expensive. In the traditional world, the real cost is more than twice the advertised cost of the home.
Here is a quick example: The FHA Loan
Probably 90% of all ordinary home sales are financed this way. You Borrow $95,000 to buy a home that appraises for $100,000. You bring $3000 to closing to pay the loan origination fee. You bring $5000 to closing for your down payment as required by FHA. You bring $3000 more to closing to cover everything else, like the attorney’s fee, courier fees, processing fees, appraisal fees, taxes, insurance, more fees, and… you get the idea.
So now you “own” a home with the following general numbers:
Appraised Value: $100,000
Down Payment $5000
Loan Amount $95,000
Fees and Costs: $6000
Private Mortgage Insurance, (PMI), currently calculated as follows: 0.078% /12 of the loan amount. Here’s how that looks: $95,000 X.0078 = $741 divided by 12 = $61.75 per month.
This “Private Mortgage Insurance” is the key to your “Government Insured” loan. The premium is added to your monthly mortgage payment. You’ll pay this insurance premium each month for about 20 years. So your $95,000 loan will cost an additional $14,820.00 for mortgage insurance.
Mortgage people will be quick to point out that PMI is what enables lower income buyers to get a home loan with a 5% down payment. Before PMI came along, the required down payment was 20%. On a $100,000 home this would be $20,000 down.
Most folks don’t have 20% down payments any more, so PMI was invented to allow home ownership for people with lower down payments. It has it’s purpose, but most buyers are usually not aware of this significant cost.
There are so many costs associated with traditional mortgage loans, that along with tax and insurance burdens, home ownership is becoming less and less affordable, in spite of “modern” financial tools like PMI.
So, back to our $100,000 does this deal look? Are we gaining equity and building a nest egg if we buy this home with a “traditional” mortgage?
Doing a quick calculation on an ordinary mortgage calculator, I came up with the following:
A $100,000 home, an FHA loan with $5000 down payment, $95,000 loan amount. 30 year fixed interest rate of 6% means you’ll pay:
$ 95,000 amount borrowed. (principal)
$ 110,046.28 in INTEREST
$ 14,820 PMI Insurance (added to monthly payment)
So your little $95,000 home mortgage has turned into an expensive alligator that will actually cost you a minimum of $219,866.28!
So, you start out as a new homeowner already $6000 in the hole, and even if your home doubles in value over the next 30 years, you’ll still LOSE $20,000!
And we haven’t even discussed the costs for property taxes, insurance and on-going maintenance.
Buying a home the traditional way is very expensive and rarely leaves the buyer with any real equity at all. Most people don’t actually realize a true profit on the sale of their home, they are simply recovering expenses already paid when they sell at a “profit”.
Whether you are buying your first home or your 50th, you should always think like a real estate investor. Look for the best deals in your desired area. Negotiate your purchase price, and buy below what you think you can afford, then prepay some principal each month from day one to reduce your costs even further.
Even better, look for sellers who are willing to owner finance for you, and avoid expensive loans altogether!