Author Topic: Saving for new house... Pay down current mortgage or strictly save  (Read 2854 times)

notoriusjt2

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We are currently about to start saving to upgrade to a newer house. If I have an extra $1000 per month to save how I choose, what would you recommend? Add the extra $1000 to current mortgage payments or just save (maybe invest) $1000 per month. We are looking at upgrading in 5-6yrs.

Current situation...
married combined income $110k

20yr mortgage with about $114k left @ 3.5%. House is worth about $160k
no other debt

max out HSA & Roth IRA. contribute 6% to 401K

-I made a spreadsheet comparing the two options and based on my calculations...
  • After 5 years I will have $140,000 equity in the house
OR
  • After 5 years I will have $63,000 in a regular savings account (1% interest)

It seems like a no brainer, but is there anything I am forgetting here?

dandarc

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Re: Saving for new house... Pay down current mortgage or strictly save
« Reply #1 on: May 15, 2015, 02:44:59 PM »
You're forgetting your regular mortgage payments in the "put the extra into savings" scenario.

You've already got 46K in equity in the house either way, so in the "savings" part of the formula, you've got 63K in cash + 46K in current equity + equity gained from appreciation (you may not be considering this on the "extra to mortgage option", in which case it should be ignored here too) + equity gained from regular payments, which over 5 years is pretty significant. 

Putting the cash in the 1% savings account means you'll likely have a little less total "housing money" than putting it all into the house, but it isn't close to 140K vs. 63K.

Having some cash around for the purchase can be good.  Earnest money and inspections have to be paid for.  You can make a cash down payment if your house hasn't sold, but you need to move on the new place.  Your old house may have gone down in value in the interim and eaten up a chunk of that equity you were counting on.

Cheddar Stacker

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Re: Saving for new house... Pay down current mortgage or strictly save
« Reply #2 on: May 15, 2015, 02:52:13 PM »
First I'd re-think whether you really need to "upgrade". If the answer is yes then:

You need to think on a more macro level. All of your finances can fit together nicely. You don't need a "savings account" strictly for a house down payment.

In 5-6 years, just chugging along with your normal mortgage payments and appreciation, you should easily have $75K in equity. That's enough for a 20% down payment on a $375K house (I'm not suggesting you buy one, just saying you will have a lot of wiggle room).

You don't need a designated savings account for the house, you need to focus on your overall investment strategy. Your timeline is not 5-6 years for needing to use this extra $1,000/month, your timeline is the rest of your life. I'd invest the money, pay the minimum on the mortgage, and if you decide to upgrade, you should be fine just using your equity when the time comes.

And max out that 401K.

thd7t

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Re: Saving for new house... Pay down current mortgage or strictly save
« Reply #3 on: May 15, 2015, 03:02:04 PM »
Your options seem to be as follow:
Use savings account: 1% return guaranteed
Pay down current mortgage: 3.5% return guaranteed
Invest with intention of drawing some out in 5-6 years: return unsure (short horizon)

As Cheddar Stacker points out, you will have enough equity for a more expensive house (although you'll pay 6% to sell your current house and closing costs on your new house, which cuts what you'll get out of it).  This is a good time for you to discuss what you need out of a new house and to optimize how much you want to have saved.  You could probably adopt a hybrid approach on this.

notoriusjt2

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Re: Saving for new house... Pay down current mortgage or strictly save
« Reply #4 on: May 15, 2015, 07:25:27 PM »
First I'd re-think whether you really need to "upgrade". If the answer is yes then:

You need to think on a more macro level. All of your finances can fit together nicely. You don't need a "savings account" strictly for a house down payment.

In 5-6 years, just chugging along with your normal mortgage payments and appreciation, you should easily have $75K in equity. That's enough for a 20% down payment on a $375K house (I'm not suggesting you buy one, just saying you will have a lot of wiggle room).

You don't need a designated savings account for the house, you need to focus on your overall investment strategy. Your timeline is not 5-6 years for needing to use this extra $1,000/month, your timeline is the rest of your life. I'd invest the money, pay the minimum on the mortgage, and if you decide to upgrade, you should be fine just using your equity when the time comes.

And max out that 401K.

Making the same payment I am making right now, I will be at $83k equity in exactly five years. Thats assuming the value of my home is the same as it is now. So you are saying to invest the extra $1000 per month. Where? in a taxable account like Betterment? Everything I read suggests keeping short term money savings (<5 yrs) out of investments in case of a downturn.

notoriusjt2

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Re: Saving for new house... Pay down current mortgage or strictly save
« Reply #5 on: May 15, 2015, 07:53:14 PM »
You're forgetting your regular mortgage payments in the "put the extra into savings" scenario.

You've already got 46K in equity in the house either way, so in the "savings" part of the formula, you've got 63K in cash + 46K in current equity + equity gained from appreciation (you may not be considering this on the "extra to mortgage option", in which case it should be ignored here too) + equity gained from regular payments, which over 5 years is pretty significant. 

Putting the cash in the 1% savings account means you'll likely have a little less total "housing money" than putting it all into the house, but it isn't close to 140K vs. 63K.

Having some cash around for the purchase can be good.  Earnest money and inspections have to be paid for.  You can make a cash down payment if your house hasn't sold, but you need to move on the new place.  Your old house may have gone down in value in the interim and eaten up a chunk of that equity you were counting on.

Here is the line item from exactly five years from now simply paying my current payment...

Date   Payment   Payment2   Interest   Principal   Total Interest   Extra Payment   Balance   Equity
6/1/20   92   $759.75    $267.47    $587.22    $30,109.66    94.95   $81,597.62     $83,402.38


Here is the line item from exactly five years from today adding in an extra $500 per month (on top of what I'm already paying)

Date   Payment   Payment2   Interest   Principal   Total Interest   Extra Payment   Balance   Equity
6/1/20   92   $759.75    $267.47    $1,087.22    $30,109.66    594.95   $51,097.62     $113,902.38

That gives me $113,902 (even though the money is tied up in the house) to use towards a down payment.

With option 1 I will have theoritcally taken that $500 and put it in a savings account earning 1% interest and on 6/1/2020 I will have $32,327.
Adding that to the equity I will have a total of $115,729. So in this scenario it actually saves me MORE money to keep paying the normal amount, plus I will have the piece of mind that those funds are liquid.

Cheddar Stacker

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Re: Saving for new house... Pay down current mortgage or strictly save
« Reply #6 on: May 15, 2015, 08:36:06 PM »
Everything I read suggests keeping short term money savings (<5 yrs) out of investments in case of a downturn.

Do you want to be average? Not trying to be disrespectful, just honestly asking. That's great advice for the middle of the road. Around here we preach to the head of the class, not the middle. Something brought you here right, so take advantage.

If you NEED the funds within 5 years, then yes, maybe don't invest it. But need means "must have to feed your family". Your needs are met. You have an extra $1k/month. Optimize. You don't need this money now. You don't need this money in 5 years. You want it for a specific purpose. If you invest it and the stock and housing markets decline right when you "want" to upgrade, simply wait a year or two.

A ship in the harbor is safe, but that's not what ships are made for. Take a small risk, and invest.  Don't think of this as short-term money. Think of this as your next 60 years. Max the 401k, put the rest in a vanguard stock index. You will have more than enough equity for a 20% down payment on an upgrade for your new house in 5 years. Take out a 30 year mortgage then, and watch your 401k grow beyond belief.

And keep reading around the forum, you will learn more than you thought possible.

notoriusjt2

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Re: Saving for new house... Pay down current mortgage or strictly save
« Reply #7 on: May 15, 2015, 09:20:52 PM »
Everything I read suggests keeping short term money savings (<5 yrs) out of investments in case of a downturn.

Do you want to be average? Not trying to be disrespectful, just honestly asking. That's great advice for the middle of the road. Around here we preach to the head of the class, not the middle. Something brought you here right, so take advantage.

If you NEED the funds within 5 years, then yes, maybe don't invest it. But need means "must have to feed your family". Your needs are met. You have an extra $1k/month. Optimize. You don't need this money now. You don't need this money in 5 years. You want it for a specific purpose. If you invest it and the stock and housing markets decline right when you "want" to upgrade, simply wait a year or two.

A ship in the harbor is safe, but that's not what ships are made for. Take a small risk, and invest.  Don't think of this as short-term money. Think of this as your next 60 years. Max the 401k, put the rest in a vanguard stock index. You will have more than enough equity for a 20% down payment on an upgrade for your new house in 5 years. Take out a 30 year mortgage then, and watch your 401k grow beyond belief.

And keep reading around the forum, you will learn more than you thought possible.

Great points here. Thanks for the info