Last year, I introduced the concept of why you should consider buying a home with an FHA loan. In the original post, I outlined the ‘base case’ for this series based on historical data. We also discussed the merits and disadvantages of using FHA loans. Additionally, we covered the requirements for an FHA loan.

Some object to FHA loans because of Private Mortgage Insurance (PMI) The base case assumed annual property appreciation of 5.4%, which is the historical average over 40 years. Under the base case scenario, new homeowners could refinance their loan and get ride of their PMI in less than three years. The homeowner’s financial wellbeing also exceeds the renter.

## Part II – Modest Inflation

In Part II of this series, we are going to look at what happens if property values increase at a slower rate than the historical average. In the base case scenario, we assumed a 5.4% annual appreciation which was the historical average over 40 years.

Today, some may argue that property values increasing by 5.4% annually is too aggressive. This scenario will assume a more modest assumption of an annual appreciation of 3.0%. We will assume the same purchase price, down payment, and monthly PITI (principal, interest, tax, and insurance) payment as the base case. Additionally, we will keep our monthly rental assumption of $1,492 in place.

As of March 2017, the US Existing Home Median Sales price was $236,600. **Buying a home with an FHA loan** requires a 3.5% down payment. A prospective homeowner would need $8,281 for a down payment if they were buying a home with an FHA loan. Yes, I know its 2019 but we are using the same data for each scenario. This makes things more apples to apples.

The table below breaks out the down payment, loan amount, and monthly mortgage expenses associated with buying a home with an FHA loan. The FHA loan interest rate is lower than a conventional mortgage by 0.25% to 0.50%. This is because of PMI.

Purchase Price | $236,600 |

Down Payment | $8,281 |

Loan Amount | $228,319 |

Interest Rate | 4.00% |

Amortization | 30 years |

P&I | $1,090.03 |

PMI | $133.19 |

Taxes | $177.45 |

Insurance | $50 |

PITI | $1,450.67 |

For comparison purposes, a prospective homeowner would need $47,320 for a 20% down payment. That’s $39,039 MORE than what it would cost to buy a home with an FHA loan.

Ask yourself, how long would it take you to save an additional $39,000?

Saving Per Month |
# of Months Required |
Years |

$100 | 390.4 | 32.5 |

$250 | 156.2 | 13.0 |

$500 | 78.1 | 6.5 |

$750 | 52.1 | 4.3 |

$1,000 | 39.0 | 3.3 |

Depending on your savings rate, it may take you between 3 years and 3 months or over 30 years to save up for a 20% down payment. Buying a home with a low down payment is starting to seem more attractive, right?

That’s because it is. But this is not the only factor to consider. While saving for your 20% down payment, more of your income is going towards rent. Time does not stand still while you are renting. As time passes by, property values are generally appreciating.

Using the same assumption as before, the table below illustrates how much you may spend on rent while saving for a down payment. The rent calculation assumes today’s median rent of $1,492/month. This figure does not include any rent increases or account for inflation; you will likely pay more given rents go up over time.

Saving Per Month | # of Months Required | Years | $ Spent on Rent |

$100 | 390.4 | 32.5 | $582,462 |

$250 | 156.2 | 13.0 | $232,985 |

$500 | 78.1 | 6.5 | $116,492 |

$750 | 52.1 | 4.3 | $77,662 |

$1,000 | 39.0 | 3.3 | $58,246 |

### Property Values Continue to Increase

Likewise, property values generally increase over time. In this scenario, we assume property values will increase by 3.0% each year.

Let’s assume you have enough money saved for a 3.5% down payment based on today’s median home price. However, let’s also assume you wanted to put 20% down instead of *buying a home with an FHA loan*. Today you have $8,281 but you would need $47,320 to avoid PMI. This means you are short $39,000.

Let’s also assume you can save $500/month towards your down payment. At this pace, you will accumulate $47,320 in about six and a half years. A lofty goal, but not unreasonable if you are dedicated.

But, during the same time property values continued to grow. The median home price is no longer $236,600. While you were saving for the past six years the median home price increased to $282,513.

A 20% down payment is now $56,503. You are now $17,464 short of having a conventional downpayment and still cannot avoid PMI. This means if you wish to avoid PMI, you’ll have to save even longer, and continue paying rent. Meanwhile, property values are probably still increasing.

The table below shows how much more you’ll need to save based on your savings rate:

Saving Per Month | # of Months Required | Years | New Home price | New 20% Down Payment | Gap |

$100 | 390.4 | 32.5 | $609,265 | $121,853 | -$82,814 |

$250 | 156.2 | 13.0 | $347,455 | $69,491 | -$30,452 |

$500 | 78.1 | 6.5 | $282,513 | $56,503 | -$17,464 |

$750 | 52.1 | 4.3 | $266,295 | $53,259 | -$14,220 |

$1,000 | 39.0 | 3.3 | $258,539 | $51,708 | -$12,669 |

Now, let’s take a look at what would have happened if you bought a home today instead of waiting for a 20% Down payment. The table below shows how much principal, interest, PMI, taxes, and insurance were paid for each of the first four years.

Year | Total P&I | Interest | Principal | PMI | RE Tax | Insurance | Total | Loan Balance | Property Value | LTV |

1 | $13,080 | $9,060 | $4,021 | $1,598 | $2,129 | $600 | $17,408 | $224,298 | $243,698 | 92.0% |

2 | $13,080 | $8,896 | $4,185 | $1,598 | $2,129 | $600 | $17,408 | $220,114 | $251,009 | 87.7% |

3 | $13,080 | $8,725 | $4,355 | $1,598 | $2,129 | $600 | $17,408 | $215,759 | $258,539 | 83.5% |

4 | $13,080 | $8,548 | $4,533 | $1,598 | $2,129 | $600 | $17,408 | $211,226 | $267,494 | 79.0% |

The table also shows the loan balance decreased while the property value increased over time. Based on this scenario, the homeowner would achieve 20% equity somewhere between years three and four.

The lower inflation scenario, compared to the base case, suggests it will take the homeowner an additional 12-months to get rid of their PMI. Upon doing so, the homeowner would experience $133/monthly savings.

### The Economic Benefit

At the end of year four, the homeowner accumulated $56,268 of equity. This includes $8,281 from their down payment, $30,894 from the property’ value appreciating over four years, and $17,093 from paying down their mortgage

Property Value @ the end of Year 4 | $267,494 |

Original Property Value | $236,600 |

Equity From Appreciation | $30,894 |

Down Payment | $8,281 |

Original Loan Amount | $228,319 |

Loan Amount @ the end of Year 4 | $211,226 |

Equity from Principal Reduction | $17,093 |

Total Equity @ the end of Year 4 | $56,268 |

After four years the homeowner would have paid their loan down to $211,226 and the property would be worth $267,494. The homeowner’s loan to value (LTV) is now 78.9%. This means the homeowner now qualifies for a conventional loan and can refinance to get rid of their monthly PMI payments. Heck, the owner could even refinance the closing costs into their loan and pay no out of pocket costs.

In this scenario, buying a home with an FHA loan now would have been better than renting.

### The rental alternative

The renter would have spent $1,984 more on rent over four years than the homeowner spent on their mortgage payment (principal, interest, taxes, insurance, and PMI). The renter also missed out on over $30,000 in equity through appreciation. Additionally, the renter will never see their rent money again. The homeowner pocketed $17,093 by paying down their mortgage. After four years of savings, the renter still may not be in a position to make a 20% down payment on a home.

Buying a home with an FHA loan or low down payment has many benefits. In the future, we will continue to explore other scenarios.

**Future posts will include the following scenarios:**

The Base Case – Buying a home with an FHA loan or low down payment

Slightly more conservative approach: Modest Inflation

The Flat Scenario: No inflation

Booming market: The Austin Housing Market

Making Extra Payments

House Hacking Scenario

House Hacking and Extra Payments

The Bust Case: When the housing market corrects

Doomsday Scenario

Nate Matherson says

Really great post! You explanation of PMI, and how it impacts the total cost was really helpful.

I’ve been doing a lot of research on FHA mortgage/loan programs lately. In my research, I’ve been surprised to find how many different state based mortgage programs there are too.