Will a federal housing administration (FHA) loan or conventional loans give me the maximum return over 30 years on a real estate investment?
I have a credit score greater than 740 and a monthly debt-to-income ratio under 20 percent. I want to invest the difference in real estate. I'm comparing monthly payments, closing costs, and down payments between either a federal housing administration (FHA) loan with a 3.5 percent down payment, or conventional loans with a 5 percent down payment and 20 percent down payment. Assuming a house value appreciation of 2 percent annually and market return of 6.5 percent annually after taxes and inflation, what loan should I take to give me the maximum return on this investment over 30 years?
I realize this may seem like a straight forward question, but it does have several moving parts. Typically, the lower the required cash outflows for a given rent the better your return. Based on the information provided, I am assuming you do not plan to invest in a REIT or other type of fund, but rather some type of rental property (residential or commercial). If this is the case, there are considerations beyond just the loan. However, for purposes of your question and assuming you are discussing residential property (commercial property has its own considerations), here are a few things to consider :
- If you take out an FHA loan (read about potential restrictions here), and only put 3.5% down, you will need to add PMI (private mortgage insurance) to your calculations. This will afect your return. You can remove it after 11 years or if the value goes up (or you pay down the loan) enough for 80% LTV (loan to value) and you refinance.
- The same will be true if you put less than 20% down on a property. You will have to carry PMI until you can qualify to remove it (80% LTV).
- Will the choice of loan make the property cash flow negative or cash flow positive? If you are not cash flow positive from the start, you are essentially taking a loss until the situation corrects itself. That loss will affect the total return.
- Regardless of the loan, in what shape is the property/building (one of those pesky "other considerations)?
There are a number of rental property calculators on the net, for example, this one. There are also a number of mortgage calculators. The shortfall of these on line calculators is they sometimes do not take into account things such as PMI amounts, vacancy rates, etc. You may want to make an appointment with en experienced advisor or other professional to help you with the details.