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With an FHA loan that only requires a 3.5% down payment, I'm able to buy a home right now and comfortably afford the monthly payments. However, I know that means I'll pay PMI and more interest over the life of the loan. A 20% down payment would allow me to avoid PMI, however it would take me around 4 years to save that amount. During those 4 years, it's very possible that home prices and interest rates will like increase.

What I'm wondering is whether it makes sense to buy a home right now with 3.5% down while home prices and interest rates appear to be at their lows (speculation) or should I wait the 4 years and buy a home with 20% down regardless of where prices and rates end up?

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For your convenience, the New York Times offers a "rent vs buy" calculator that's actually half decent; you can fill it with the appropriate set of assumptions here: nytimes.com/interactive/business/buy-rent-calculator.html –  fennec Apr 14 '10 at 2:08
    
FYI: You will only pay the PMI until you have 20% equity in the home, not for the entire life of the loan. That can happen if either the house appreciates in value or you pay down the loan, or a combination of both. –  JohnFx Apr 14 '10 at 5:10
    
For the PMI recalculation, do they do it for you, or do you have to ask and get a new appraisal? –  MrChrister Apr 14 '10 at 16:11
    
I believe for an FHA loan I need a new appraisal + need equity = 20% of appraised value rather than purchase price. I've also heard that the first 5 years of PMI are mandatory regardless of equity... –  cabbagecalculator Apr 14 '10 at 19:08
    
With an FHA loan, you have to pay mortgage insurance (which is NOT PMI, see my answer below) until you reach 22% equity (78% LTV), AND you have paid the insurance premium for 5 years or more. –  msemack Apr 20 '10 at 22:33
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8 Answers

up vote 13 down vote accepted

I say yes. The realtors will have you think you're missing a golden opportunity no matter how the market actually is. (I know, I've asked them before AND after the bubble burst).

You actually save a LOT of money renting longer. The interest, PMI, HOA, insurance, repairs, extra utilities furniture all costs you wouldn't have spent renting.

People always buy a house bigger than they need, while renting you can move only when you need extra space.

In short - think of a house as an expense, not as an investment. Don't buy a house until the expense is worth it on its own.

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So true. There are so many hidden costs to owning a home. –  Mike Apr 14 '10 at 4:09
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@Mike: You know it. They told me I wouldn't miss my landlord when I bought my first home, but I do. He fixed stuff! –  JohnFx Apr 14 '10 at 20:55
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One correction to the above answers: You do not have PMI with an FHA Mortgage. PMI is Private Mortgage Insurance.

FHA mortgages have their own mortgage insurance that is government-backed (Not private). FHA Mortgage Insurance is subject to different terms and rates than PMI.

The two are similar, but different. Not being aware of the differences can come back to bite you later.

This is a good overview of FHA Mortgage Insurance: http://www.fhaloan.com/fha_mortgage_insurance.cfm

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Like others have suggested, I'd recommend waiting until you have at least 10%, if not 15% or 20% for a downpayment on a house. One additional fact to consider: you need a larger rainy day fund in case of disaster if your house payments are larger than your rent payment (and you can much more easily move to a cheaper apartment than a cheaper house)

I'd highly recommend reading this book on buying a house associated with the Wall Street Journal - it clearly describes the benefits and challenges of owning a house. One key takeaway I had was - on average houses have a "rate of return" on par with treasury bills. Its best to buy a house if you want to live in a house, not as thinking about it as a "great investment".

Additionally there was a rule of thumb stated on the Motley Fool website (I cant for the life of me find the link) stating that a good rule of thumb about house prices is to do a quick calculation to determine if you should buy in a housing market: If (Price of house) / (monthly rent * 12) < 20, you should consider buying. If its > 20, then you're probably better off renting.

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FYI (since I can't leave comments)... Going FHA means that you have to pay huge closing costs for up-front PMI (doesn't go towards principal or interest, and can be around 4-5k on a 250k home!!!).. Also, going FHA means you are LOCKED INTO PMI until you are 20% equity.

With a conventional loan, you don't pay any up-front PMI at closing; and you are not locked into the PMI; after 2 years (some lender 1) you can have your house re-appraised, and if you are now 20% equity, you are rid of the PMI.

I suggest doing neither - don't wait till you're 20%, and don't buy w/ an FHA. Put down 10% and get a conventional loan and get the best of both worlds.

I just closed on my first home a few weeks ago, and have to say it's worth it. I have a .4875 rate, on a 264k home with 10% down, and all my bills (less utilities) are around 1750. It's a 4 bedroom/2 bathroom house - renting even a shitty 1 bedroom/bath apartment in this area costs 1k, 2 bedrooms go for 1250, and anything remotely nice would be the cost of my mortgage,PMI, and home owners insurance combined!!!!! Add to the factor that I can write-off ~26k in just my first year of interest/PMI and you will realize that renting is SUCH a waste of money at least here in the state of NJ!! I also have a fat 8k check waiting to be mailed to me to furnish my home =)

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This is a great question:

I personally would wait for the 20%. Having 20% equity would make me more comfortable being that I have already bought a home and I am not very much upside down. That being said, I think there is no definitive answer since you are essentially gambling the price will go up.

Here are some upsides of waiting:

  • You own a lot more of your home when you do buy
  • You get time to shop around and really know what you want
  • You get time to really decide what neighborhood you want to live in
  • You get aren't in a huge debt for a while, so you can afford other things like cars and vacations
  • You won't pay PMI to protect the bank
  • You won't have to pay for all the upkeep a house requires and the little bills and efforts
  • You can stay mobile if the job market improves
  • You can prove to yourself that you are a dedicated saver
  • You get compound interest working for you, not against you
  • If you don't have a family, maybe you will in four years and you can decide together

Some upsides of not waiting:

  • You could very well be buying at the bottom of the market, which is good
  • You are therefore probably going to gain equity
  • You aren't "throwing away" your money into rent
  • You get a nice tax break in the US on the interest of your loan
  • You are probably at a low / near low for interest rates on a fixed mortgage right now

I personally think the market for houses will stay depressed for a few more years, even if it doesn't lose any more value. I would wait for the 20%, even if that meant I paid a little more. I don't think the market will bounce back so quickly that you would lose out o a great opportunity if you bought in 3 or 4 years.

Please keep in mind I am negative on buying a home as I have been burned before. There are very likely more practical responses than mine. But ultimately I feel that since you are asking the question, you really can't afford it. You might have the money now, but I am talking about the long term risk.

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Just my personal opinion, but I don't think we're at the bottom yet, at least not everywhere in the US. –  C. Ross Apr 14 '10 at 13:56
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It depends. What kind of rent do you pay now? How big/small a house is it and what would the total payments be? More than that, what is your motivation to buy? If you bought and the market dropped 30% from here, would you panic or just say "I plan to be here 10 years, I don't really care what's it's worth day to day"?

I've stated many times over that the crash would not have occurred had we stuck to lending w/20% down and no teaser rates. With the low downpayment, the risk is not on you, it's on the bank or PMI issuer. That said, I'd look closely at your own numbers to decide.

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I also say yes. If you say it will take four years to save the required amount, why not be aggressive and set a target of three years but making extra money and trimming expenses? Also, while it is certainly possible that prices could rise in three years, it's also possible they could stay flat or fall.

In any event, good luck in your home ownership journey!

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You're going to need more than 3.5% on a house that requires 3.5% down, as a note; closing costs and repairs in the first few months will eat up a lotta cash.

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