You may already know that FHA loans are assumable. If you don’t know what this means, you might want to read on. If you already know what an assumable loan entails, you might want to see the numbers that follow. In essence, if someone sells a home that is financed with an FHA mortgage, they can transfer the outstanding loan (it’s rate, balance, and remaining term) to the new buyer, provided they qualify for the loan, of course. If they don’t qualify, they probably won’t be buying your house, or another one like it.
THIS IS A BIG DEAL
Let’s assume (no pun intended) that a borrower refinances their $155,000 house today with a $150,000 FHA mortgage on a 30 year fixed at 4.25%, today, with virtually no closing costs ( aside from a $400 appraisal). This was possible today, with a loan amount of 150k or greater.
The mortgage payment, excluding property taxes and home owners insurance, associated with the above terms (150k @ 4.25% on a 30 year FHA) would be $880/ month.
$738/month Principle and interest payment
$142/ month PMI
Please note property taxes and insurance have been left out, as “they are what they are”. I should point out that FHA loans do require borrowers to escrow taxes and insurance along with the mortgage payment.
(Fast forward 5 years)
After making the regular, minimum monthly payment of $880 on the $150,000 mortgage for 60 months, the borrowers current mortgage balance is $136,211. The owner of the home is ready to make a move, on top bigger and better things. Lo and behold, there is a potential buyer who is considering making a $150,000 offer (sorry about the number, we hope home is going to go for $200k, but in my jaded example, it’s 150k). The mortgage consultant (let’s name him Todd… why not?), who made the FHA refinance recommendation five years earlier, reminded you every year or so, to strongly leverage the benefit of the 4.25% assumable FHA loan which they fortuitously obtained back in August of 2011.
$738/ month (25 years remaining)
$132/ month PMI (PMI goes down about $2 a year on this size loan)
Just for the purpose of making a point we will say that prevailing 30 year FHA fixed rates are 6% in 5 years. Jeez, I don’t know, maybe 30 year FHA rates will be 4% in 60 months. But, then again, maybe rates are 11%, PMI on new FHA loans has tripled, our unit of currency is the Yuan, our children are learning Mandarin ever since Uncle Sam defaulted on “our” interest-only payments. I digress…ok, where was I… Oh yes, it’s 2016, rates are only 6%, we all speak English, and gas just dipped to $8.49 a gallon, and someone is considering buying your home for 150k!
The buyer is considering another house (House A) for $150,000 with a 30 year FHA fixed rates at 6%, or our sellers home (House B) which offers the assumable FHA loan at 4.25% with a $136,211 balance and 25 years remaining.
At this point I have one question:
How do you feel about making some more assumptions? Lets do it, after all, we are talking about assumptions. Not just because it’s fun, we need to.
So let’s assume that FHA down payment guidelines and PMI are the same. Assuming things are going to be no worse is really stretching reality, but lets just pretend. After all PMI just keeps going up, and they (“they” are the same people that decided in the early 90s’ that everyone should be a home owner, regardless of credit or ability to pay) are talking about raising the FHA downpayments.
House A : The house without an assumable mortgage.
The mortgage payment on the $150,000 house on an FHA with 3.5% down at 6% is $1000/month.
$876/month principle and interest on a $146,197 loan amount, plus $124/month PMI. The PMI figure is arrived at by averaging the decreasing PMI over 136 months. (As a rule PMI falls off naturally on month 137 when not making extra principle payments.)
So
$1000/month for the first 136 months (at which time the PMI falls off)
then
$876/month for the remaining 224 months.
Which equals
$136,000 in total payments over 136 months
and
$196,224 over the last 224 payments
for a total of
$332,224 in P+I payments over 30 years
House A: Cash to close
3.5% down = $5250
Estimated closing costs of = $4,000. In the real world, they will ask the seller to pay it, but don’t worry, I’m not going there.
1% upfront PMI to HUD = $1,447
Cash to close to buy House A = $10,697
House B: Has the assumable FHA rate @ 4.25%.
This house involves a variable that must be discussed. The buyer must come up with the difference ($13,789) of the $150,000 sales price plus the mortgage they are assuming ($136,211). This can be handled a few ways:
1) The seller has the cash to make up the difference – let’s not assume that, it would screw up all of these numbers I am working on.
2) Seller provides buyer a second mortgage in the amount of $13,789. Seller and buyer would have to agree to the terms, and have a mortgage written up and filed. If you want to play banker, more power to you.
3) Buyer secures a loan to make up the difference.
The most likely scenario is option 3, so let’s go with that. Although most people aren’t aware of it, there are many credit unions and banks that that will do this type of subordinate loan. For the sake of producing numbers, let’s say the borrower gets a loan for $13,789 @ 8% on a 15 year amortization = monthly payment of $132. FHA will allow this, and they will actually allow the loan to be either mortgage or a personal loan.
The mortgage payment on a $150,000 house on House B is $992
$738/month principle and interest on a $136,211 loan amount, plus $132/month for the second mortgage, plus $122/month PMI (averaged) over the first 76 months (after which time it would cease, as the seller already had paid PMI on the loan for the first 60 months).
Payments would be :
$992/month for the first 76 months (at which time the PMI falls off)
$870/month for the next 104 months (at which time then the 2nd mortgage is paid off)
$738/ month for the last 120 months (at which time the mortgage is paid off)
$75,392 ($992 x 76 months)
$90,480 ($870 x 104 months)
$88,560 ($738 x 120 months)
=
$254,432 in P+I payments over 25 years
House B: Cash to close
$0 DOWN
Closing costs of = $1,800 ($500 FHA assumption fee <max>, title fees of $1500)
Loan amounts = $150,000 ($137,573 assumed mortgage, $12,427 second mortgage)
Cash to close = $1800
Summary:
Out of pocket for potential buyer
Out of pocket and closing costs to close on House A = $10,697
Out of pocket and closing costs to close on House B = $1,800
Costs $8897 less for the buyer to acquire House B.
Total of payments and out of pocket expenses
Total of mortgage payments on House A = $332,224 + $10,697 at close = $342,921
Total of mortgage payments on House B = $254,432 + $1800 at close = $256,232
House B could save a buyer up to $86,689
Mortgage debt payments by month*
Months 1-76:
House A: $1,000
House B: $992
Months 77 – 136:
House A: $1,000
House B: $870
Months 137 – 180:
House A: $876
House B: $870
Months 181 – 300:
House A: $876
House B: $738
Months 301 – 360:
House A: $876
House B $0
*Do not misunderstand these numbers; it does not take 25 years for the buyer to realize the majority of the savings House B offers (months 301-360). What is happening is that the assumable FHA loan is building equity faster, as a greater percentage of your monthly mortgage payment is going to principle, rather than interest.
It is fair and correct to average the savings / equity built by taking $86,689 and dividing it by 30 years. House B is building nearly $3000 more equity each year compared to the other house in this scenario.
Things to consider:
- Would you like to be able to offer Option B when you go to sell?
- How much could Option B impact the value of a home?
- 30 year fixed FHA loans must have PMI for 5 years. After 5 years if you are at 20% equity or greater it will be removed. How might this change your numbers?
- FHA loan servicers are required to offer a 12 month forbearance period for borrowers who have lost their jobs. What value might this have to a family with a lost income?
- Point : If rates take off with inflation not too far down the road, do you really want to be paying off 4% tax deductible interest at a faster pace than you need to? Counter-point: There sure is nothing wrong with becoming debt free, ASAP.
- Would you overpay to have an FHA loan (because of the PMI) for 5 years, just to have the ability to offer Option B, when it’s time to sell?
- FHA maximum loan sizes in Ohio vary from $271,050 to $432,500.
- County limits can be found here https://entp.hud.gov/idapp/html/hicost1.cfm
- FHA loan limits may decrease in the near future.
Todd Lipps
www.OhioMortgageadvisor.com
