Purchasing an extremely affordable home with 10% down VS renting and saving for 20%

Question

Background:

• Current Rent: 710/mo or roughly 20% of my 3700 salary take-home pay.
• Wife is currently in school and will graduate in two years, at which point she will likely be making a teacher's salary. Currently does babysitting and other jobs to contribute, which I don't take into account as "guaranteed monthly income" to be on the safe side.
• Current lease is up in 4 months (mid-February).
• I'm not planning on moving for at least 5 years.

More on the new house:

We found a home that is recently renovated (attempted flip) that we love. This would be our first home purchase. The house is listed at $85,000. We currently have enough for a 10% down payment (we could put more, but don't want to use ALL our savings (unless that's for some reason a good idea).

For a 15 year mortgage and 10% down payment, zillow.com gives these options:

30 Year Fixed: 4.24% $376 /mo
15 Year Fixed 3.76% $557 /mo
5/1 ARM: 3.07% $325 /mo

It seems we're qualified for an FHA loan, but I'm not sure what these give us, as I haven't researched them.

My question is: Is it a financially sound move to become homeowners at this point given our background? I'm worried about not having a 20% down payment, and would rather save it up. However, on the plus side, the monthly payment would likely be $200 less/mo with this house vs our current rent. On a 30 year mortgage it would be almost $3-400 less. This makes me think that I could use the difference to pay directly toward the principal each month. Is my logic sound? Smart move, even with the risk of breaking/paying out a lease (which we could do)? or should we continute to spend money on rent while trying to save money for the 20% down payment?

Answer 1

A few things to keep in mind. A 90% mortgage is $76,500, PMI for 10% down is $76,500/2300 = $33/mo. This, plus $557 is still lower than your rent. I'd take the 15 since you want to get rid of that PMI as soon as you can. Often the bank will require the PMI be removed only after the regularly scheduled payments have gotten you to 20% equity, prepayments mat not count. This may have changed recently. Check to be sure. Even in 5 years, you'll save compared to the rent, and from this point, odds are it will increase in value. I'd not count on any tax deduction. Your standard deduction is $11,400. Even at the higher rate, you'd have $3200 in interest, property tax can't be over $2000. You have an easy tax return, I'd say. Good luck.

UPDATE - it's now 2016 - The standard deduction is $12,600 for a couple. With the interest maybe at $3200, and property tax at $2000, curious why any other readers would think the OP would be itemizing.

Answer 2

If you can get a mortgage with 10% downpayment and the seller will accept (some may want at least 20% downpayment for whatever reasons) and with PMI it still lower than your rent, sounds like it's a good idea to buy now.

Of course this assumes that the money you'd be otherwise saving for 20% downpayment will be used to pay off a mortgage faster.

Answer 3

Whenever you put less than 20% down, you are usually required to pay private mortgage insurance (PMI) to protect the lender in case you default on your loan. You pay this until you reach 20% equity in your home. Check out an amortization calculator to see how long that would take you. Most schedules have you paying more interest at the start of your loan and less principal. PMI gets you nothing - no interest or principal paid - it's throwing money away in a very real sense (more in this answer). Still, if you want to do it, make sure to add PMI to the cost per month.

It is also possible to get two mortgages, one for your 20% down payment and one for the 80%, and avoid PMI. Lenders are fairly cautious about doing that right now given the housing crash, but you may be able to find one who will let you do the two mortgages. This will raise your monthly payment in its own way, of course.

Also remember to factor in the costs of home ownership into your calculations. Check the county or city website to figure out the property tax on that home, divide by twelve, and add that number to your payment. Estimate your homeowners insurance (of course you get to drop renters insurance, so make sure to calculate that on the renting side of the costs) and divide the yearly cost by 12 and add that in. Most importantly, add 1-2% of the value of the house yearly for maintenance and repair costs to your budget. All those costs are going to eat away at your 3-400 a little bit. So you've got to save about $70 a month towards repairs, etc. for the case of every 10-50 years when you need a new roof and so on.

Many experts suggest having the maintenance money in savings on top of your emergency fund from day one of ownership in case your water heater suddenly dies or your roof starts leaking. Make sure you've also estimated closing costs on this house, or that the seller will pay your costs. Otherwise you loose part of that from your down payment or other savings.

Once you add up all those numbers you can figure out if buying is a good proposition. With the plan to stay put for five years, it sounds like it truly might be. I'm not arguing against it, just laying out all the factors for you.

The NYT Rent Versus Buy calculator lays out most of these items in terms of renting or buying, and might help you make that decision.

EDIT: As Tim noted in the comments below, real monthly cost should take into account deductions from mortgage interest and property tax paid. This calculator can help you figure that out. This question will be one to watch for answers on how to calculate cost and return on home buying, with the answer by mbhunter being an important qualification

Answer 4

Unless the taxes are above 3000 per year it looks like a good deal to buy (the 30 year mtg)

You could also consider getting the 30 year loan and add additional principal to your payments.

It looks like your PMI might be about $50 per month.

You will get to deduct over $3000 in interest payments the first year as well as the real estate taxes.

Depending on your tax rate that might be something like $100 per month or so of incentive to chose buying over renting.

The big issue to consider is the risk of big ticket items to repair.

You should keep a fund for this kind of thing...

water heater, roof, fridge, cesspool, etc.

good luck

Answer 5

Not really money related, but: how long are you going to be staying there? Once your wife graduates, would you be potentially moving to another area, or needing to move to be closer to where she works?

If so, you might want to wait until after she graduates and you know where you'll be, before putting down money on large stationary items like houses.

Answer 6

I realize this question is a few years old now, but I wanted to address one of the OP's questions that hadn't been answered yet (my answer is framed as though the question were recent):

However, on the plus side, the monthly payment would likely be $200 less/mo with this house vs our current rent. On a 30 year mortgage it would be almost $3-400 less. This makes me think that I could use the difference to pay directly toward the principal each month. Is my logic sound?

The way amortization works, if the interest rate between 30 and 15 were the same, then making principal-only prepayments on the 30 year to cover the difference in monthly payments would result in the exactly the same schedule as if you did minimum payments on the 15-year - i.e. the numbers would be practically indistinguishable. Of course, in practice the interest rate is slightly better on the 15-year, which makes the 30-year with prepayments compare slightly less favorably.

If you're confident that you'll be able to reliably keep up with the monthly payments, the 15-year would minimize the total amount of interest you pay, and help you get off of PMI slightly faster. But the 30-year w/ prepayments gives you the option to skip a prepayment or two if you run into any financial difficulty, which is a nice option to have. But you do have to be disciplined about making the prepayments every month.