Author Topic: FHA + low equity + assumability = win (?)  (Read 3561 times)

mandelbrot

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FHA + low equity + assumability = win (?)
« on: May 15, 2013, 09:20:29 AM »
Hey Mustache kingdom,
Rookie  homebuyer + wife here trying to understand as much as possible before we actually find and pull the trigger on a house. Well, in Austin's super-fast-paced market, we've already tried that a few times, but we're taking a brief break to consider some sudden advice from a friend.

So you know, my "friend" is a self-made millionaire, one of these people who happens to be a closet mustachian. He's more than twice my age and in my eyes a Grand Old Master of finance and shrewd life decision making. His name is John.

Now you know who he is, so John gave me this advice: even though you can afford a conventional 30yr fixed loan with 20% down and get a great rate on it right now, you should get an FHA instead. This is not because of the lower down payment, and an FHA loan surely has little else going for it since the origination costs are higher and PMI is there for a long time. But, there's one thing that's amazing about FHA loans, he said: assumability.

That is, FHA loans can be transferred. So, that means in say 5-6 years when we might decide to sell the house, our ~3.8% APR FHA loan is going to be much more valuable than the house itself that we're selling. This is because, as I am told, it is rather unlikely that interest rates will be this low ever again. In 5-6 years rates could be back up to 6, 8, 10%, who knows? In that case, even assuming our home appreciated very little, the financial instrument of our FHA loan would actually be extremely valuable. Since it is assumable, we would hope to sell it to some enterprising individual who has enough cash on hand that he / she could pay down to the remaining balance of our original loan, and we would walk away with a small net profit -- if my calcs are right. Of course, my calcs are just mostly blind shots in the dark.

So, there is the scenario. I've tried to understand this quickly, and I think I've gotten the gist of it. But, money / finance instruments are still very new to me -- I really am very much a n00b here. So I have some questions about these things. You may answer all or any of these you wish, or even any questions that I didn't think to answer:

  • Do you buy this story that interest rates are definitely going to rise, and substantially, in the next few years? How sure of you are this? I know almost nothing about how this works, but I know it is the story that everyone seems to be hawking.
  • I'm still not quite sure I follow why someone would (in the scenario above) want to pay us a big chunk of cash on a less-valuable home simply because the remaining payments will be burdened with lower interest. Such a buyer (perhaps an investor) with cash in his pocket would likely be able to put down a large down payment on a nicer and more cash-flow-lucrative home than what he'd be buying from us. But, I guess running comparisons side by side, I can see that perhaps the interest differential would be more than enough to overrun the potential upside of buying a better (but more interest-burdened) home. I suppose also that assuming the FHA would be less risky as well since the investor could pass on such a loan to somebody else if he/she ever needed to. Okay, maybe this particular item isn't exactly a question.
  • If the scenario I outlined above takes place and we have a higher-interest environment at the time we're selling the house, how on earth would we know how to price such a house?
  • Overall, does this FHA thing seem like a good plan to you? I have to admit the numbers work out pretty positively looking at some simple math on it all. That's assuming very little appreciation in the house itself. But again my numbers could be wildly inaccurate.
  • Finally, key question: in Austin we've had trouble getting the attention of sellers simply because the market is filled with competitive buyers and investors. We've had to jump up to putting down 20% + offering higher than list price on every home we've seen, simply to get our feet in the door. In those most recent cases, we have been beaten out anyway by other buyers who are presumably offering even more cash down at the outset, which (I've been told) indicates to the seller that that buyer is more likely to make it to closing -- and that's why they select that buyer. So *IF* we take John's advice and try to play the current interest environment by going with an FHA ... how are we supposed to get the attention of the seller? With only 3.5% down, that is?


Hopefully all that holds together alright. I welcome all clever comments, questions, and wise observations! Let me know how this looks to you all. Thanks as always.

Starstuff

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Re: FHA + low equity + assumability = win (?)
« Reply #1 on: May 15, 2013, 10:15:07 AM »
I've retyped this three times trying to come up with a good answer... This could be a good idea, okay idea, or bad idea.

So, riddle me this:

How long are you going to stay in this house? Is your goal to "own a home" or are you just renting a place from the bank for a few years? Would you consider making this an investment property, or are you certain you're going to sell?

mandelbrot

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Re: FHA + low equity + assumability = win (?)
« Reply #2 on: May 15, 2013, 10:21:19 AM »
Hey Starstuff,
Thanks for jumping in here.

Our house and life goals are relatively flexible at this point, and we could adjust our plans according to the type of financing we choose, type of house we choose, etc.
Ex:
1) If we get an FHA loan, the best reason to do so (so far as I can understand) would be to take advantage of selling it in a few years, once we find ourselves in a rising interest environment. I have no doubt that we could arrange ourselves to be ready to move out and move on somewhere else in 5-6 years, or whatever timeframe that would be. But, I see there's inherent risk here, because what if (somehow) interest rates never rise as we intend?

or

2) If we stick with how we've been advised by most people, which is just to do a 20% down conventional 30yr fixed loan, then we would be open to staying in it longer, and just renting it out when we find ourselves ready to move. At least, in my rather nascent understanding, I think that would be the better move in that case, since we'd be taking advantage of (again presumably) a loan that would have a much lower rate than what I could then find in the market, and would also be unburdened with PMI of any kind.

Hope that conveys the intent here. We're flexible. We could move or stick around, rent it out, etc. Our goal is not necessarily to own a home and have it all paid off. In fact from what I understand, paying off a low-interest loan too aggressively or too early is actually counter to the overall goal of Building Our 'Stache as Best and as Quickly as Possible, since the "return" on paying down a low interest loan is actually probably going to be less than the real return you'd get in the open market, say Index funds, etc.

And our goal, ultimately, is the Building Stache thing I bolded above.

Starstuff

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Re: FHA + low equity + assumability = win (?)
« Reply #3 on: May 15, 2013, 11:15:59 AM »
I'm really struggling to answer this question... In general, I'd say run from FHA loans like they carry the black death. The organization is a nightmare. Mortgage insurance is expensive, and it's a huge cost that you likely won't recoup just because your loan is assumable. And, if you only put 3.5% down, you're going to pay a shitload of interest and have almost zero equity in five years, which to me is more of a risk. If Austin is a rapidly appreciating housing market, you could run into a burst bubble just as you're ready to sell. Then you're stuck with an expensive loan with no way of offloading.

If I were you, I'd get pre-approved for a 30 year fixed around 3.5-3.75% with 20% down at the absolute highest loan amount you'd consider. Pre-approval means all you have to do is call the bank and say "I found a place," they send out the appraiser, and if you get the value you need, you close. That will be much more appealing to a seller because they won't have to wait around on the off chance that you'll get approved. And at such low rates, you have a good chance of having a solid rental property on hand in five years, if that's in your 'stache plan.

Another Reader

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Re: FHA + low equity + assumability = win (?)
« Reply #4 on: May 15, 2013, 11:59:03 AM »
Around 1980, the ONLY way you could sell a home was with an assumable loan.  Mortgage rates were 16 to 18 percent and no one could qualify.  Wraps were common as well.

FHA loans are assumable by owner occupants.  The buyer has to qualify according to FHA guidelines.  No appraisal is required.

Let me see if I understand this.  You want to pay a hefty up-front fee and a monthly MI premium on the chance that someone will pay you a little extra for the house because it has a below market interest rate but comes with a monthly MI premium that lasts the life of the loan.  That buyer also has to qualify for the loan under then current FHA standards.

Even if this made sense, your problem is that sellers in your market have no reason to deal with the additional hassles of an FHA loan.  There are plenty of well qualified conventional and cash buyers to pick from.  A competent listing agent will advise the seller to take a cash or conventional offer. 

No, this is not a "win."


mandelbrot

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Re: FHA + low equity + assumability = win (?)
« Reply #5 on: May 15, 2013, 01:13:19 PM »
Thanks AR, that may have been what needed spelling out for me.

A couple things that were useful:
1) I didn't realize until doing further research today that any FHA loan, regardless of amount down (even 20%) has PMI for the life of the loan. That is a real deal killer, and makes it obvious that the "resale" value of my assumable loan would be not nearly as sensational as I initially imagined.
2) Makes sense what you said about competing with other buyers -- if FHA is more of a hassle for the seller (I'm not sure how but I guess you understand this) then there would be no reason for the seller to select me among a half dozen other offers that are conventional and possibly higher percent down.

That might be all I need, thanks guys.

Another Reader

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Re: FHA + low equity + assumability = win (?)
« Reply #6 on: May 15, 2013, 01:30:00 PM »
The real question is what will happen to home prices when the stimulus that is keeping interest rates artificially low disappears.  Those 20 percent overbids will become a thing of the past, and the folks overbidding to snag a property may find their equity position deteriorating.  Two or three years from now you may be thanking your lucky stars you did not buy a house during the frenzy that you must then sell or rent to move to the next job in another location.

Johnny Aloha

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Re: FHA + low equity + assumability = win (?)
« Reply #7 on: May 15, 2013, 02:32:03 PM »
Assuming the FHA is worth pursuing - which I don't think it it - how would you estimate the extra "value" of the house based on assumability of this loan?

Add $5k?  3%?  50%?

Another Reader

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Re: FHA + low equity + assumability = win (?)
« Reply #8 on: May 15, 2013, 03:10:57 PM »
It was worth a lot in the early 80's. 

You could do a discounted cash flow analysis of the payment difference over the remaining term of the loan if you knew the market interest rate at the time of the second sale, but the real worth is to someone that can only qualify under FHA and can qualify for that payment with MI.  Folks in that situation generally don't do a DCF to figure out what they will pay.  And we would have to speculate on what the interest rate will be anyway.

The short answer is the arbitrage value, if any, can't really be determined.