Out of all of the parts of the home buying process, probably the most intimidating and bewildering is the process of figuring out “how in the heck are we going to actually pay for this?”. Here’s the good news… it’s really not all that complicated when you have a solid understanding of how financing works and know what your options are. Let’s break it down!
Plot twist, the first option is to not finance it at all. I’m talking the ultimate option: cold hard cash, baby.
It’s a great feeling to be able to say that you own your home free and clear and it speaks volumes about your financial planning ability to be in a position to do this. In the Savannah region about 18% of sales on average are cash transactions. This, of course, depends heavily on the property being sold. Small, cheap homes, especially those in a state of disrepair or that don’t qualify for typical financing (like older mobile homes) are much more likely to be purchased with cash than larger, more expensive (and more mainstream) homes.
There are some benefits to paying cash (and some are pretty big). The most obvious and significant is that you’re not going to have to pay interest on the money that you’re spending (opportunity 
cost is a topic for another day and a different audience). That’s a pretty huge benefit, really. Let’s take a $200,000 loan as an example at a 4% interest rate (which is pretty conservative, historically speaking) over 30 years. Over the course of the loan, you are going to pay a whopping $143,739 in interest that would be avoided if you were to pay cash. Paying cash in this instance would save you almost $4,800 a year!
The other notable benefit is often not as lucrative as most buyers expect: negotiating leverage. Don’t get me wrong, there are situations where dropping the c-word can potentially get you big discounts on the sales price, but in the cast majority of cases the seller doesn’t care if you pay with a loan, cash or livestock (okay, part of that statement is inaccurate).
Let’s take a typical, mid-priced suburban home for example. It’s in great shape, this particular seller has it listed at a reasonable price and it’s been on the market for three days. There’s plenty of interest in it and he’s still going to have to move out once he finds a buyer. He’s got a great listing broker who is vetting buyers thoroughly and requiring a pre-qualification before negotiating. In this situation the seller doesn’t have to worry much about low appraisals (since it’s been well priced), doesn’t have worry about inspections or lenders’ minimum property requirements (because it’s in great shape) and doesn’t have any reason to rush into a closing (because he’s going to need time to prepare as well). All other things being equal, he’s going to walk away with the same amount of money in his pocket whether you pay cash or finance it with a loan. In this type of situation there’s really no benefit to the seller for you to pay cash and therefore you’re not going to see any real discount on the sales price as a result.
Alternatively, let’s look at a completely different situation. You’ve found a manufactured home on the edge of town which is a little rough around the edges, whether or not the foundation is considered “permanent” is questionable (more on that in another article) and the seller is an investor who has rented it out for the past ten years but now has it sitting vacant. Cash in this situation can accomplish a lot for you as a buyer. The seller knows that if you’re paying cash instead of trying to finance the purchase with a loan he’s not going to have to worry about the appraisal coming in low, the lender requiring a ton of repairs in order to write the loan or having a structural engineer fail the foundation on lender guidelines. In addition, it’s sitting there empty with no rent money coming in but with all of his expenses continuing to accrue. This is the type of situation where paying cash can net you big discounts up front.
THE BOTTOM LINE FOR CASH
WHEN TO DO IT: When saving interest over the long haul is appealing, when the seller is in a rush, or when the property might be difficult to finance for most people.
WHEN TO AVOID IT: When interest rates are drop dead low, or when the property is one that should be easy for most other people to finance without problems.
Despite all the benefits of paying cash, there can be benefits to financing real estate with a mortgage loan as well.
Firstly (is that a word?), opportunity cost is a real thing. I know I said that this was a topic for another day and another reader but let’s tackle this one anyways. This is going to matter mostly to investors but can potentially have relevance to John Q. Public as well so we’ll hit it really quickly. Opportunity cost is “the loss of potential gain from other alternatives when one alternative is chosen”. Simply put, if you spend all of your money on a house, you’re not going to have the cash sitting around to pursue other potentially lucrative opportunities, like investing or paying for other less attractively finance-able things (like car loans or high interest credit cards and installment loans). In comparison to almost every other type of loan, mortgage loans represent some of the 
cheapest money you’ll ever come across. Interest on a mortgage loan is usually significantly less than a car loan and a mere fraction of credit card interest rates. Due to this, you may be much better off using your savings to pay cash for your car and pay off your other loans or credit cards instead of using it all on your home.
Another potential benefit (or perhaps more accurately, “offsetting factor”) is the Home Mortgage Interest Deduction. If you file an itemized tax return you may be eligible to use the interest on your mortgage (up to a $750,000 loan amount) as a deduction on your income taxes. It’s not a reason to finance in and of itself, but it does help to take some of the sting out of the interest paid, especially when you consider that interest on other loan types is not deductible. For this reason (like the last), you may be better borrowing money on your home rather than financing a car (which would not offer deductible interest).
The biggest factor more most people however is the substantial increase in buying power that financing offers. Let’s set all of that pesky logic and practicality aside for a moment and consider an undeniable truth (assuming that this isn’t an investment property)… the home you are buying is going to be the place where you are going to spend the upcoming years of your life. It’s going to be the place where you raise your kids, or the place where your parents come to visit, or the place where you entertain guests or business associates. Financial responsibility be damned, sometimes there are very good reasons to spend a little more than you have. Or maybe you’ve found a gem of a property that for whatever reason presents a lot of potential for increases in value that you wouldn’t otherwise be able to afford. If you have the income to support it, that $100,000 cash budget can very easily become a $500,000 mortgage budget.
THE BOTTOM LINE FOR FINANCING
WHEN TO DO IT: When interest rates are super low, or if you have other needs that can be better met with cash (like a new car, credit card debt or other installment loans), or when you don’t have enough cash to buy a property that meets your needs or desires.
WHEN TO AVOID IT: If you’re loaded and have no other needs or debts. And if this is the case, why are you reading this?
If you’ve decided that you’re like the rest of us that comprise the aforementioned 82% of the market, you’re going to have to figure out what type of financing to pursue. Here in the lowcountry, there are four types of financing which are predominant. The frequency of each type varies from area to area. For example, in Hinesville, VA financing is heavily favored and represents about 59% of the sales in that market due to the heavy influence of Fort Stewart and the overwhelming presence of military service members living off-post. Conversely, in Savannah only about 14% of the sales in the market are secured with VA financing because of the relative lack of military presence in the housing market.
Conventional loans can be considered the basic, bare bones option when it comes to mortgage loans. They’re widely available, there’s not a lot of requirements or restrictions (relatively speaking) and if you can afford to go this route you’re probably better off. Conventional mortgages generally offer up to 80% financing (although LTVs up to 95% are available, but you give up a lot of the benefits of conventional financing if you go this high). That means you are going to have to come up with 20% of the purchase price in cash as a down payment, which is not necessarily a bad thing — you’re walking into your door on day one with equity in your home.
There are a couple of benefits to conventional loans. The first one is probably more of a benefit to the seller than you, and can therefore result in a little bit of negotiating leverage for you to help get the best price on your home. Conventional loans typically do not have the same “minimum property requirements” that you will see on other types of loans. That doesn’t mean that anything goes… the house can’t be falling apart at the seams, but it doesn’t always have to be in absolutely perfect condition either. Sellers like this because they don’t have to worry about minor repairs becoming an 
issue that they have to deal with in order to satisfy your lender. They also don’t have the same requirements on location that rural development loans do or documentation that some other loan types do.
The biggest benefit to conventional financing, however, is the lack of “funding fees” or mortgage insurance (provided that you aren’t financing more than 80% of the purchase price). These can be significant expenses and that’s a lot of money that you can save if you can go the conventional route rather than some of your other options.
THE BOTTOM LINE FOR CONVENTIONAL FINANCING:
WHEN TO DO IT: When you’ve got some cash in the back and can afford a 20% down payment, or if the house you’re buying needs a little bit (but not a lot) of TLC.
WHEN TO AVOID IT: If you’re low on cash and need to finance more than 80% of the purchase price.
FHA loans are great for first-time homebuyers. The program is generally intended for low to moderate income buyers and requires a lower minimum downpayment and credit scores as compared to many conventional loans. As of today (2020), FHA loans will allow you to borrow up to 96.5% of the purchase price of a home (meaning your down payment can be as low as 3.5%). Additionally, buyers with credit scores as low as 580 may qualify for FHA financing. Borrowers with lower credit scores (500 to 579) may still quality for financing with an increased downpayment (10%). Additionally, your down payment doesn’t necessarily have to come from your own bank account — it can also be a gift from a family member or a grant from a down-payment assistance program (which are not as prevalent as they used to be).
Interest rates on these loans are sometimes slightly lower than conventional loans, however this is offset by the mortgage insurance premiums (“MIPs”) that you’ll have to pay in order to get an FHA loan. There are two types of MIPs involved with FHA loans: the Upfront Mortgage Insurance Premium (“UFMIP”) which is 1.75% of your loan amount and Annual Mortgage Insurance Premiums (“AMIPs”) which range from 0.45% to 1.05% of your loan amount on an annual basis depending on multiple factors. Typical AMIP on an FHA loan is about 0.85%. The upfront premium can be added to your loan amount and financed, however the annual premium gets tacked onto your payments, usually for the life of the loan.
To put this into perspective, the $200,000 loan that we discussed earlier would require an upfront premium of $3,500 plus $51,000 in annual premiums over the 30 year life of the loan — a considerable expense over the conventional loan which would require neither.
The other caveat is that FHA requires that the home being purchased be in pretty good condition overall. FHA’s minimum property requirements (the minimum physical condition of the house) are a lot more strict than other forms of financing. For this reason, if you’re trying to get a deal on a fixer-upper, FHA is probably not the option for you.
There is a loan limit on FHA loans which changes on an annual basis and varies based on property type. At the time of this writing the single-family home loan limit for all local counties (Liberty County, Bryan County, McIntosh County, Long County, Chatham County and Effingham County) was $331,760
THE BOTTOM LINE FOR FHA FINANCING:
WHEN TO DO IT: If you don’t have much money in the bank or your credit isn’t perfect and the house you are buying is in excellent condition.
WHEN TO AVOID IT: If you have the cash and credit score necessary for conventional financing or if you’re buying a property that needs some work.
USDA financing is actually very similar to FHA financing and is based heavily on the FHA program but offers one very significant benefit over the FHA program: 100% financing (no downpayment!). Here’s the rub… USDA loans are only obtainable for properties that are in areas that are approved as rural areas (in reality rural areas and some suburban areas provided that the population is under 35,000 people). Generally speaking areas like Midway, Richmond Hill and McIntosh County would be qualifying areas while Savannah would not be. Additionally, the USDA minimum property requirements generally echo FHA’s requirements, so the house must be in good condition.
Like FHA, USDA has relaxed requirements for credit scores, income, etc. as compared to conventional mortgages and may have lower rates but also requires significant “funding fees” and mortgage insurance (although it’s called something else). The program also has income limits, so high earning households may not qualify for this type of financing at all. Extremely low income households may qualify for direct USDA funding which can carry interest rates as low as 1%.
USDA loans require a 1% upfront fee and an annual 0.35% fee for the life of the loan (which can be compared to FHA’s mortgage insurance premiums). For our prior example, the $200,000 loan would cost an additional $2,000 upfront (which can be added to your loan amount and financed) as well as $21,000 in annual fees over the life of the loan.
Also like FHA, there is a loan limit which varies based on the location of the home. As of the time of this writing (2020), the loan limit for most counties in Coastal Georgia is $265,400.
One major drawback to USDA financing is that funding for the program has to be renewed by the legislature on an annual basis and there have been interruptions in funding these loans in the past due to political delays. This can be a problem when the disruption in funding occurs in the middle of your purchase and you are left high and dry hoping that the seller is willing to be patient. For this reason it’s critically important to work with a knowledgeable and experienced lender for USDA financing who can warn you of anticipated delays and issues.
THE BOTTOM LINE FOR USDA FINANCING:
WHEN TO USE IT: When interest rates are low and down payment money can be used more effectively for other things and the house you are buying is in good shape, under $266k and in a rural area.
WHEN TO AVOID IT: When your household income is relatively high, the house is a handyman special or in an urban area, or you have sufficient credit and funds on hand to get a conventional mortgage with fewer fees.
VA loans are available to active duty and retired military service members and, like USDA, offers 100% financing with no down payments but without many of the caveats.
There are no requirements on the location of the property for VA loans. The VA program does have minimum property requirements, however they are generally less stringent than FHA or USDA requirements. Interest rates on VA loans are generally lower than other loans types and loan limits are higher than FHA or USDA loans ($484,350 at the time of this article).
There is no ongoing mortgage insurance premium with a VA loan, although most borrowers will be required to pay a “funding fee”. The VA funding fee is either paid up front in cash or can be added to the loan amount and financed. The amount of the fee varies based on certain criteria (veterans who have service-connected disabilities, Purple Hearts, or surviving spouses of disabled veterans or veterans who died in service may be exempt from funding fees) but ranges from 1.4% to 3.6%. Most first time homebuyers financing 100% of the purchase price will pay a 2.3% funding fee. In connection with our hypothetical $200,000 loan this would equate to an additional $4,600 over a conventional loan.
THE BOTTOM LINE FOR VA FINANCING:
WHEN TO USE IT: When you don’t have a lot of money for a down payment and you’re a veteran or active-duty soldier.
WHEN TO AVOID IT: When the house you’re buying isn’t in good overall condition or if you have sufficient credit and cash to obtain conventional financing to avoid funding fees.
There is no “best” type of financing for everybody. Your individual situation, motivations and the property that you are purchasing are all going to influence your smartest choice when it comes to paying for your home. Consultation with an experienced real estate broker and/or mortgage loan officer is invaluable in determining the option best suited for your needs. Give me a call at (912)312-0403 and we can talk about your needs and refer you to a number of competent and experienced mortgage lender who can help you make this important decision in the most beneficial manner for you!
Brandon Boyce is a REALTOR® and Associate Broker with Islands Real Estate Company in Midway, Georgia. He has been a fixture of the Coastal Georgia real estate market for over two decades and specializes in the marketing of coastal and waterfront properties in Midway, Georgia and Richmond Hill, Georgia.