20% Down or 0% Down with Money in Escrow (Theoretical)

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I doubt this is feasible or if any bank would do it. Also, I'm trying to figure out if there is an error in my thought process, but it seems (if there were no PMI) that it would be FAR more beneficial to put 0% down and use that down-payment money for monthly payments.

Assumptions:
House Value: $1,000,000
Down Payment 20%: $200,000
Rate: 3.75%
Years: 30
P&I: $3,705

If $0 down, P&I would be $4,631.

If you could put the $200,000 down payment into an escrow account from which the mortgage would be paid and you paid $3,705 (what your mortgage would be if you put 20% down) into it and it earned 0.5% per year, you would have payments for about 19 years! At that time, the house value may have doubled and inflation would have reduced the real value of your monthly payments in half. Even if you earned no interest, you'd still be good for 18 years. Even with PMI and no interest, you're still good for over 12 years, and then you could eliminate PMI.

Other than ignoring PMI (which is a big one), what am I doing wrong?
Why would anyone put anything more than the minimum to avoid PMI?
Is this feasible?

Just an example of the data for one year:
200000
199156.9
198313.5
197469.8
196625.7
195781.2
194936.4
194091.3
193245.7
192399.9
191553.7
190707.1

Edit: Numbers were wrong but idea is the same.
Edit2: Eliminated the part about house appreciation (irrelevant to the point).

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samko said:   Other than ignoring PMI (which is a big one), what am I doing wrong?
Why would anyone put anything more than the minimum to avoid PMI?
Is this feasible?

Yes.
That's why 20% is needed to avoid PMI and higher closing fees..., unless its payed by the lender and rolled into the rate on the whole balance being increased and no PMI.
No, without a high effective interest rate on the last 10-20LTV.

A simpler way to look at PMI, is, in general:  When you pay $1000000 for the house, it's immediately only worth ~$900,000.  Because that's all you'd get if you sold it immediately, due to transaction costs.  If you defaulted on the loan immediately, the bank would only recover <$900000 for selling the house.  That's why you have to pay for insurance when you do high-LTV loans so that if they have to foreclose they can recover the $100k it's underwater, there's no other reason someone sane would lend you more than the asset value. (And this, of course, ignores the possibility of the property value decreasing after purchase and becoming more underwater)

Edit:  There are actually some programs with "0 down" secured by >2X normal down payment in assets held in the bank's brokerage firm.  But at that point they're usually more expensive or cumbersome than just taking a margin loan out separately to pay the down payment on a normal mortgage.  Citi, for example calls these "Dual Collateral" mortgages.  They reference it online, but it looks like you'd have to contact them for the details.

It's getting late and I have no idea what the hell you are talking about. The bottom line is unless you can find a place to park your $200k for a return greater than your mortgage interest, you are not coming out ahead.

samko said:   
After 18 years, your house might be worth about $2,000,000 (assuming 4%/yr) and your mortgage balance would be about $500,000. At that time, you could refinance the entire $2,000,000 and repeat the process putting $400,000 in the escrow account and pocketing $1,100,000. Then you're good for another 3 years at which time you sell and retire.


You sound like one of those people who would get an interest-only mortgage.

Oops, misread the interest rate on the escrow account.  This isn't arbitrage, but the house-as-an-ATM angle does reek of 2008.  I'll make you the deal all day long if you'll pay me 3.75% interest to borrow money and let it sit in a 0.5% escrow account.  You're losing 3.25% a year on that balance.

The long-term play isn't affected at all by how you finance the house in the first place (though you've lost 3.25% a year on whatever you had sitting in the escrow account over that time).  The long term play is a wash based entirely on the notion that you've assumed $1,000,000 in appreciation, on which you realize $1,100,000 in the refi and pay back the $100,000 at sale.

samko said:   Assumptions:
House Value: $1,000,000
Down Payment 20%: $200,000
Rate: 3.75%
Years: 30
P&I: $4,747

If $0 down, P&I would be $5,673.
 


P&I on a 30 year $800K mortgage at 3.75% is $3,704.92. On a $1,000,000 loan, P&I is $4,631.16. Where did you get $4,747?

Can you break down how you got $5,673 on $0 down? What interest rate will you be getting at $0 down? How much is the PMI?

Bend3r said:   
samko said:   Other than ignoring PMI (which is a big one), what am I doing wrong?
Why would anyone put anything more than the minimum to avoid PMI?
Is this feasible?

Yes.
That's why 20% is needed to avoid PMI and higher closing fees..., unless its payed by the lender and rolled into the rate on the whole balance being increased and no PMI.
No, without a high effective interest rate on the last 10-20LTV.

A simpler way to look at PMI, is, in general:  When you pay $1000000 for the house, it's immediately only worth ~$900,000.  Because that's all you'd get if you sold it immediately, due to transaction costs.  If you defaulted on the loan immediately, the bank would only recover <$900000 for selling the house.  That's why you have to pay for insurance when you do high-LTV loans so that if they have to foreclose they can recover the $100k it's underwater, there's no other reason someone sane would lend you more than the asset value. (And this, of course, ignores the possibility of the property value decreasing after purchase and becoming more underwater)

Edit:  There are actually some programs with "0 down" secured by >2X normal down payment in assets held in the bank's brokerage firm.  But at that point they're usually more expensive or cumbersome than just taking a margin loan out separately to pay the down payment on a normal mortgage.  Citi, for example calls these "Dual Collateral" mortgages.  They reference it online, but it looks like you'd have to contact them for the details.

  But if the bank has the money in an escrow account, what do they have to lose? The 20% down is still there.

IMBoring25 said:   This feels like 2006 all over again.

What you're describing is called arbitrage and it was very popular in 2006 and is becoming so again. With "play money" it's one thing and you'll probably come out ahead in the long run, but when you're talking about doing it with your primary residence, the thing you're leaving out is risk.

The market performs well over time, but has ups and downs on shorter time horizons...The time horizons of concern when you need to, say, make a mortgage payment. A lot of people found out in 2008 that property values don't always go up and got left holding the bag with a big payment and no ability to refi or sell for what they owed, especially if they encountered a large expense or job loss for which they hadn't properly planned.

  I understand what you're saying and I'm okay with the house going down in value. The only risk to the bank is if it goes down more than 20%, but they have that risk anyway even if I put 20% down.

anthonyu said:   
samko said:   Assumptions:
House Value: $1,000,000
Down Payment 20%: $200,000
Rate: 3.75%
Years: 30
P&I: $4,747

If $0 down, P&I would be $5,673.


P&I on a 30 year $800K mortgage at 3.75% is $3,704.92. On a $1,000,000 loan, P&I is $4,631.16. Where did you get $4,747?

Can you break down how you got $5,673 on $0 down? What interest rate will you be getting at $0 down? How much is the PMI?

  You're right. I used motgagecalculator.com, but I must have missed an entry somewhere. I'll re-run my numbers.

Sorry, I've updated the post. I thought it was one of the old, "Mortgage the house to the hilt and put the cash in the market," schemes. If you put money into an account where it earns less than your mortgage rate, you're losing money. All the money you think you're making here is from the appreciation you're assuming, and that is there regardless of how you finance the purchase.

IMBoring25 said:   Sorry, I've updated the post. I thought it was one of the old, "Mortgage the house to the hilt and put the cash in the market," schemes. If you put money into an account where it earns less than your mortgage rate, you're losing money. All the money you think you're making here is from the appreciation you're assuming, and that is there regardless of how you finance the purchase.
  Fine, forget the part about the home value appreciating. It's irrelevant to the point.

You could cover 18 years of payments if you put your down payment into an escrow account and made the regular payments into that account. You would even be covered for 43 months in case you couldn't make any payments.

unnamedone said:   It's getting late and I have no idea what the hell you are talking about. The bottom line is unless you can find a place to park your $200k for a return greater than your mortgage interest, you are not coming out ahead.

samko said:   
After 18 years, your house might be worth about $2,000,000 (assuming 4%/yr) and your mortgage balance would be about $500,000. At that time, you could refinance the entire $2,000,000 and repeat the process putting $400,000 in the escrow account and pocketing $1,100,000. Then you're good for another 3 years at which time you sell and retire.

 


You sound like one of those people who would get an interest-only mortgage.

  If I could get a low, fixed rate for 30 years, why not? This, of course, requires that you are one who is disciplined to save and you assume you can invest at a rate better than the appreciation of a house.

IMBoring25 said:   Oops, misread the interest rate on the escrow account.  This isn't arbitrage, but the house-as-an-ATM angle does reek of 2008.  I'll make you the deal all day long if you'll pay me 3.75% interest to borrow money and let it sit in a 0.5% escrow account.  You're losing 3.25% a year on that balance.

The long-term play isn't affected at all by how you finance the house in the first place (though you've lost 3.25% a year on whatever you had sitting in the escrow account over that time).  The long term play is a wash based entirely on the notion that you've assumed $1,000,000 in appreciation, on which you realize $1,100,000 in the refi and pay back the $100,000 at sale.

  The reason I'd prefer to have the down payment in a bank account is that I have the security of knowing I can make payments for a number of years. If I only have $200,000 and I use it all for the down payment and I'm unemployed for a period of time, I lose the house.

Pull correct amortization schedules and see what the mortgage balances are at the 18 year mark. You should find your scheme has you owing a little over $100k extra on the house at that point. It's reverse arbitrage.

If you're wiping out your emergency fund you're buying too much house. If you lose your job you still have other expenses that won't be coming out of that escrow account...And you should find PMI with the lower down payment should cost less than half what your escrow account scheme would.

samko said:   
anthonyu said:   
samko said:   Assumptions:
House Value: $1,000,000
Down Payment 20%: $200,000
Rate: 3.75%
Years: 30
P&I: $4,747

If $0 down, P&I would be $5,673.


P&I on a 30 year $800K mortgage at 3.75% is $3,704.92. On a $1,000,000 loan, P&I is $4,631.16. Where did you get $4,747?

Can you break down how you got $5,673 on $0 down? What interest rate will you be getting at $0 down? How much is the PMI?

  You're right. I used motgagecalculator.com, but I must have missed an entry somewhere. I'll re-run my numbers.
 

So the updated numbers are below. These are P&I assuming that you get the same interest rate with 0% down as with 20% down. Also, PMI depends on your credit profile and the LTV, so it will be higher at 100% LTV vs. 90% LTV. Zillow has a mortgage calculator that estimates PMI to be $817, although I think is a bit on the high end (for comparison, Zillow estimates my PMI to be $259 and I'm paying $170). You will have to get a quote to find out what rate you will get and the PMI costs at 0% down, and you may end up finding out that it will cost you more to do so than just putting the usual 20% down..

https://www.zillow.com/mortgage-calculator/
samko said: Assumptions:
House Value: $1,000,000
Down Payment 20%: $200,000
Rate: 3.75%
Years: 30
P&I: $3,705

If $0 down, P&I would be $4,631.


 

Thanks all for pointing out the flaws which are that the remaining balance after 18 years will be much higher and it may actually be cheaper to pay PMI. However, if you qualify for a VA loan, there is no PMI, but the limits are not that high.

I guess it's a form of insurance to make sure that I have a buffer. The question is whether it's worth it and if I can earn more than 3.75%+PMI in other investments long term.

It mostly comes down to the fact that houses appreciate more slowly than the stock market has done historically. I know, I know, that past performance, blah, blah, blah.

Houses usually appreciate more slowly than the stock market, but at 5x leverage (at the very start at least), it's pretty common for owners to gain more than they would have with the general stock market. With PMI, you might even start leveraged 20x or 30x.

There are loan programs for certain types of professionals that offer 0 down, no pmi, and competitive interest rates(1/4 to 1/2 point above normal)... in those situations it can work out to a great deal. Of course these are non-conforming loans that will be held by the lender -- but the default rate is super low due to the types of people they are loaning to.



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