Buyers of owner-occupied homes don’t typically think of themselves as investors trying to make money, so they pay full price for a home and get a government-insured loan for the purchase, without giving it much thought. Most of your attention is focused on choosing the right neighborhood or the right style and location. These are fundamentals that are more important to them than money. In a way, they assume that their house will eventually increase in value.
The other sector is the 20% of buyers and sellers that make up the investment market. These are sellers who sell at a discount and buyers who buy at a discount. These buyers and sellers are consciously trying to make a profit and their goal is to make money or build wealth.
But I believe that all homebuyers are real estate investors, for the simple reason that no one buys a home with the intention of losing money. But with government-insured loans, this is often what happens.
As a result of ongoing government intervention since the great depression of the 1930s, today’s mortgage industry has become a half-private, half-public money machine turned monster.
While government-insured loans like FHA, VA, and USDA were created to help low-income homebuyers pay off a home mortgage, the result has been very expensive loans that will more than double the cost of a home loan.
Note that I said the cost of the loan. Not the cost of the house. The property value is set. It is the costs of the loan that go up. And few loans are more expensive than government-insured loans that are supposedly designed to help low-income homebuyers.
Most retail buyers who use a traditional FHA (government-insured) mortgage to buy a home don’t even realize the true costs over time. Traditional home loans can be very expensive. In the traditional world, the actual cost is more than double the advertised cost of the house.
Here’s a quick example: the FHA loan
Probably 90% of all ordinary home sales are financed this way. You borrow $95,000 to buy a house that is appraised at $100,000. Bring $3,000 at closing to pay the loan origination fee. Bring $5000 at closing for your down payment as required by the FHA. Bring an extra $3,000 at closing to cover everything else like attorney fees, courier fees, processing fees, appraisal fees, taxes, insurance, plus fees, and… that’s done. idea.
So now you “own” a house with the following general numbers:
- Appraised Value: $100,000
- Initial payment $5000
- Loan Amount $95,000
- Fees and costs: $6000
Private Mortgage Insurance (PMI), currently calculated as follows: 0.078% /12 of the loan amount. Here’s what it looks like: $95,000 X.0078 = $741 divided by 12 = $61.75 per month.
This “private mortgage insurance” is the key to your “government insured” loan. The premium is added to your monthly mortgage payment. You will pay this insurance premium every month for about 20 years. So your $95,000 loan will cost an additional $14,820.00 for mortgage insurance.
Mortgage folks will be quick to point out that PMI is what allows low-income homebuyers to get a home loan with a 5% down payment. Before PMI came along, the required down payment was 20%. We have a $100,000 house, this would be a $20,000 down payment.
Most people no longer have 20% down payments, so PMI was invented to allow people with lower down payments to own homes. It serves its purpose, but most buyers are generally unaware of this significant cost.
There are so many costs associated with traditional home loans that, along with tax and insurance burdens, home ownership is becoming less and less affordable, despite “modern” financial tools like PMI.
So, back to our $100,000 house… what does this deal look like? Are we gaining equity and generating savings if we buy this house with a “traditional” mortgage?
Doing a quick calculation on an ordinary mortgage calculator, I came up with the following:
- $100,000 house, FHA loan with $5,000 down payment, $95,000 loan amount. 30-year fixed interest rate of 6% means you will pay:
- amount of $95,000 borrowed. (important)
- $110,046.28 in INTEREST
- $14,820 PMI insurance (added to monthly payment)
So your small $95,000 mortgage has turned into an expensive alligator that will actually cost you a minimum of $219,866.28!
So, you start out as a new homeowner with $6,000 in the hole, and even if your home doubles in value in the next 30 years, you’ll lose $20,000!
And we haven’t even discussed the costs of property taxes, sure Y Maintenance in process.
Buying a home the traditional way is very expensive and rarely leaves the buyer with any real value. Most people are not actually making a true profit on the sale of their home, they are simply recouping expenses already paid when they sell at a “profit.”
Whether you’re buying your first home or buying your 50th, you should always think like a real estate investor. Search for the best deals in your desired area. Negotiate your purchase price and buy below what you think you can afford, then prepay part of the principal each month from day one to further reduce your costs.
Even better, look for sellers who are willing to finance for you and avoid expensive loans altogether!