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Sorry this is a bit long. Novice homebuyer here...We just put an offer in on a house at below estimated value. It was accepted today. We qualified for an FHA loan. We have closing costs covered and the seller is contributing to the closing costs. We are not using a realtor-it’s a private sale with a real estate attorney/title company.

My question is do we do a 15 year Loan of $295k at 3.75% or a 30 year loan at 4.5%. Our plan is not to stay in this house forever. Minimum 2 years probably maximum 5 years. Just looking out 26-28 months I did some amortization numbers ( not a math person so this could be wrong!)

The amount of the loan balance in June 2020 with a 30 yr loan is $287,921 with a payment of 2151 a month. With a 15 year it is $262,295 with a $2791 payment per month (+$640/month or $16k for the timeframe noted) That a difference of $25,626 in equality over the next 27-28 months.

The house needs some updates. We’re not rolling in discretionary income but can do the $2791 payment but it would make us feel cash/house poor. We have $100K in savings, but don't want to touch that. But perhaps the equity we’re building outweighs the inability to make those potential updates? (Or do much else fun) Or no?

Considering we know we got the house for pretty much below market and appraisal value ($335K range), even if the value drops are we better served getting the 30 year at a slightly higher rate and using the $650 difference for house updates that should make it more marketable? Or do we do the 15 year, be a bit house poor, not make as many updates and build equity in a house we may not be in more than 2-3 years or so?

We’ve been renting and renting is not an option. I understand lots of different costs are associated in moving after only a few years etc. I just want to know which mortgage is the most bang for our buck in our situation? Thanks!

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    If 600 difference make you House poor then so does the lower house payment. That said neither are a good option as if you are strapped after the payment you’ll be opening yourself up to all sorts of trouble. – Eric Feb 14 '18 at 4:44
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    What percentage down are you putting? How much savings do you have after the down-payment? – Hart CO Feb 14 '18 at 5:00
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    Buying a home requires -- God how I hate this term -- a holistic view of your family finances, not just whether or not you can make the payments. @Eric and HartCO both raise good points. Also, can payments be made if you or your partner loses your job? – RonJohn Feb 14 '18 at 6:10
  • I'd just rent. Houses cost a fortune to upkeep, and unless the market is utterly skyrocketing in your area, in 99% of cases all the expenses, interest etc swamps any small price gain. – Fattie Feb 15 '18 at 13:42
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Depending on your savings and monthly income levels, walking away from this purchase could be the most prudent option. Do you have enough savings after the down-payment to cover an expensive repair on day 1? Enough to keep up on payments for a few months in the face of job-loss? Not enough information to recommend not buying, just things to consider in case you might be over-extending.

Barring that option and focusing just on the 15 vs 30 year mortgage, I suggest a 30 year loan. Over 29 months you'd have an extra $25k in equity with the 15-year, but you'd have made almost $19k more in payments. So while that extra $6k would be great, it sounds like you need that $650/month more since you don't have much cushion. The longer you stay, the more lucrative the interest savings from a 15-year loan become, but if the higher payment stretches your monthly too thin it introduces risks that could easily negate the savings.

The above numbers are calculated with just a simple amortization schedule, but with an FHA loan there is additional overhead. You'll pay an up-front mortgage insurance premium of 1.75% (typically added to your loan) as well as an annual premium (currently 0.45-.85% of 12-month average loan balance depending on down-payment and loan term). If there's any way you can get a conventional loan (they go as low as 5% down) you would still have mortage insurance, but you can typically get it removed when you hit 20% equity, while with an FHA loan you could be saddled with insurance for the life of the loan. This is why a lot of people target a 20% down-payment.

There will also be property tax, insurance, and potentially expensive repairs on day 1, but those don't vary based on loan options.

Edit: Comments paint a very different picture than I got from the question originally, but ultimately you just need to decide if you'd rather have interest savings or extra liquidity. If you're comfortable with your current level of liquidity then any extra you throw at the down-payment up front or extra monthly on a shorter loan term will save you interest, whether or not you could do something better with your money is also for you to decide. With $100k in savings, a 15-year seems the better option.

Those conventional rates/PMI sound pretty ugly, I haven't shopped with low credit so might just be out of touch there, closing costs shouldn't be that different, the big thing is the extra 1.75% ($5,162) mortgage insurance up front with FHA that you don't get back (you can get a prorated amount of it applied if you sell and take out another FHA loan), over the life of a loan you could make up for it, but in 2-3 years that extra overhead is very significant.

  • Sorry I should have been more clear. Due to some poor choices and cavalier inattention our credit scores are in the mid to upper 600’s. So we have less than desirable credit but plenty of income. We’re working on getting our credit score up but it doesn’t happen overnight. We currently live in the house we’re buying. So no moving costs. Landlord has advised basically buy or I’m listing. Houses sell quickly in our area, there is huge demand and low inventory and there are no rentals in our school district. We went month to month with our previously 2 year lease because we thought we – Sashall Feb 14 '18 at 12:21
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    thought we were moving a year ago and didn’t want to have to break the lease. By house poor, I meant within our strict budget. We have the money to cover needed expenses in savings and we carry little to no debt. Our self imposed housing budget is 3K. We have six figures in savings but want that to stay where it is. With the 30 year it allows more cushion in the housing budget to do updates without raiding the savings.We looked at conventional and the rate was higher and PMI was through the roof for the same loan. We didn’t want to put more than 10% down because we’re not staying here forever. – Sashall Feb 14 '18 at 12:24
  • We’re not expecting the property to particularly make money, but would like to not lose money. Closing costs with conventional loans are double the FHA costs. – Sashall Feb 14 '18 at 12:24
  • best rate we were offered on conventional loans was 5% with 10% down minimum. FHA Rate is 4.5 or 3.75 depending on length of loan with 10% down. PMI with the conventional 30 year with 10% down was about $500 a month. And yes I understand that 20% down changes things a lot but is it better to put that extra 10% into a house that may not appreciate in 3 years? – Sashall Feb 14 '18 at 12:38
  • ...let me also add that rental costs for homes in our area that accommodate our family with 3 kids and two work from home adults is anywhere from $2800 to $3200 per month. So paying a $2800 mortgage is actually lower payment than renting and if we don't buy this house moving somewhere else is required. We do not have an option to stay and rent. Renting elsewhere would involve higher rent and moving costs. – Sashall Feb 14 '18 at 14:02
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I would lean towards the 15 year since it sounds like you can barely swing it. The main reason I say this is because you have over $100K in savings to handle any problem months that could crop up. I'd probably take that even further and say even if you can't quite afford the 15 year payment I'd still do it and have a slight deficit each month because of the extra interest savings you'll get. Or, perhaps you could dig into your savings to put just enough extra down to drop the monthly amount low enough so you can afford it. When you sell in a few years you'll get that money back anyway, and it's always best to try to avoid paying interest on a loan when you have cash sitting in the bank that could cover it (once your emergency fund is in place).

To put this in perspective, on the 30 yr mortgage you will pay $13,178 in interest in the first year, vs $10,808 in interest with the 15 yr mortgage. That's a savings of $2,370 in the first year alone. It would be unfortunate to pay over $2K per year in interest when you have the cash to avoid it.

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Whether you should get a 15 or 30 year mortgage has little to do with how long you plan to live in the house. The real question is, Can you afford the higher monthly payments for the 15 year mortgage?

The total cost, principle plus interest, for a 15 year mortgage is substantially less than the total cost for a 30 year mortgage with the same interest rate. You are only paying interest for 15 years instead of 30 years, and you are paying down the principle faster. On top of that, you usually can get a lower rate for a 15 year mortgage. (As apparently you are able to do here.)

But a 15 year mortgage has higher monthly payments. If there was zero interest, than to pay off the loan in 15 years instead of 30 each payment would have to be twice as much. Interest and amortization makes the formula more complicated in the real case, but each payment on a 15 year mortgage is going to be substantially more than the 30 year.

So in this case, you have a choice of 3.75% for 15 years which I calculate to $2145 per month, or 4.5% for 30 years which comes to $1495 per month. (Principle plus interest. You'll have taxes and insurance on top of that, I don't know the numbers for your case.) So if you stayed in the house until you paid off the mortgage, the 15 year loan would cost a total of 15 x 12 x $2145 = $386,100 while the 30 year loan would cost 30 x 12 x $1495 = $538,200.

So if you can afford the higher monthly payment, it's tougher in the short run, but in the long run you'll came out way ahead. If you can't afford the higher monthly payment, than discussion of the long run advantages is irrelevant because you just can't do it. You'd be yet better off to just pay the whole thing in cash at closing and never pay any interest, but most people can't do that so it's a moot point.

The only real difference that the amount of time you will live in the house makes is if the bank offers you a lower rate in exchange for paying points. If by making a larger up-front payment you can get a lower rate, then if you stay in the house a long time this is more likely to pay off.

  • +1. I like this answer. The only thing I disagree with is that IMHO even if OP can't quite afford the 15 year it is still the better choice due to the large available savings. I clarified in another answer. – TTT Feb 14 '18 at 17:19
  • Would the DVer please explain? – TTT Feb 14 '18 at 17:20
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    They'll save money with a lower rate, no doubt, but it's the compounding nature of the interest that makes it so significant over the life of a loan, if the compounding time is reduced then the impact of the rate difference is also reduced. – Hart CO Feb 14 '18 at 18:08
  • @HartCO - when I read your comment I was inclined to agreed with you, but then I ran the numbers and the difference is almost $2400 in interest for just the first year. – TTT Feb 14 '18 at 21:08
  • @HartCO The "compounding nature" is what makes the first years so disadvantageous, in terms of interest to principal ratio. Less time to term, less compounding, less interest paid - for the life of the loan, but especially at the beginning of the term. – Beanluc Feb 14 '18 at 21:48

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