Often times, homeowners are faced with the challenge of knowing which financing option is best for them and they ask if they should refinance their FHA loan to a regular loan. In this article, we would be taking a look at both financing options in a view to help you determine which is best for you. So first let me explain what each are.
Meaning of FHA Loan
A FHA loan an FHA loan is a government insured loan which means that if a bank issues an FHA loan and let’s say they loan it for a $100,000 mortgage and then I the borrower refused to pay it then the government’s FHA’s program will compensate the bank so that the bank doesn’t lose as much money from not having to foreclose and that whole thing. The government does this because they want to help more people afford mortgages now why would that help them afford mortgages here’s why because FHA allows for a lower down payment. Then therefore to buy a property you don’t need a full 20% like a regular loan.
On the other side of this equation, a regular loan usually requires 20% down. Anytime you are buying a property and you put less than 20% down there’s a thing that kicks in called mortgage insurance PMI or in the case of FHA they have their own name for it MIP and so it’s basically monthly payment that you have to pay because you have to pay the bank to cover the FHA. It is kind of like the payment for the insurance, so it’s not like the government on the FHA loan just wants to be nice to you necessarily and giving you this low down payment. They are charging everybody that gets an FHA loan or any under 20% loan, the insurance companies are charging a fee for this ability to have a cheaper loan and so it adds on to your payment.
FHA Versus Regular Loan
Now this is not exact but it’s fairly good to estimate that every hundred thousand dollars that you financed for PMI is going to be about a hundred dollars, again it’s not exact but it is pretty close. So if you had a $200,000 mortgage and you had to have PMI on it, it is probably going to be a couple hundred dollars a month. So as you can imagine that would add quite a bit to your mortgage, so let’s just say you bought that $200,000 property and you put 3 ½ % down not only is your payment higher than a regular loan because you have a higher payment because you didn’t put as much down like you have a higher balance you also have this PMI. So let’s just say there’s a property you want to buy and it is $200,000 now you could use an FHA loan which is three and a half percent which is $7,000. So you are putting $7,000 down meaning you’ve got a mortgage now for a $193,000, now you are going to have some closing costs too so let’s just round up you’re going to pay about $10 to a $100,000 property.
For a regular loan, 20% of $200,000 is $40,000 plus you know let’s say $3000 for closing costs so you have got $43,000 to buy it and you’ve got $10,000 for an FHA. So you can see the difference, at least the FHA is cheaper. However, on one hand the regular loan is for a $160,000 because we put $40,000 down while on the FHA we have a mortgage for $193,000, so it’s a much higher loan balance there for a higher monthly payment and then you’re going to add on the monthly PMI charge on top of that so now not only do you have the higher payment you have the PMI as well and so in terms of which is better the reason I can’t say one versus the other is certain situations are going to be better or worse and so what I like to see is I think of like a rental. FHA can’t be used for rental properties but it can be used for like a duplex or a triplex or a four-plex as long as you plan on living in the property for a year.
So what I’m driving at here is the idea of if you’re going to use one of the two maybe look at your return on investment especially if you’re doing this house hacking idea of living in a duplex triplex or four-plex you can kind of look at your return on investment but you can do it with a single-family house as well what kind of like return are you getting you in one way versus another is it costly would you be better off saving that money and investing it in the stock market or in another rental property or another hedge fund or I don’t know whatever you want to do with your money like do you have another use for the money.