Author Topic: Should I make a large downpayment on a house? Finances aren't my thing - help!  (Read 1196 times)

gipsygrrl

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I struggle with finances,which is how I found MMM and why I'm here... I'm trying to learn- one painful dollar at a time! But I'd love some thoughts on whether to make a large downpayment on a home. I have $180k in cash (from the sale of a previous house). I'd like to buy a home for $350k. My thought was to use a large portion of that cash to make a big 'ole downpayment, thereby giving us a nice, low monthly mortgage. A low mortgage seems like it would buy flexibility for my family - more money each month to sock in our retirement accounts, to travel a little bit, and to build a cushion for expenses that come up. But I'm also reading articles that say "Don't put more than 20% down!" and I don't completely understand why.

More on our situation: no debt, but pretty underfunded retirement accounts. Husband and I are in our mid-30's and have one small kiddo that we need to start a college fund for. We're not high-earners - we make about 90k combined/yr. We're buying a house in Colorado, which has (and is still) experiencing lots of growth and booming housing markets (which of course is not guaranteed forever). I'd estimate us keeping the house for 7-10 years and hopefully doing pretty well on it, if trends continue.

Is there a reason I SHOULDN'T sink most of my cash into this downpayment?

J Boogie

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I think this one depends quite a bit on you and your husband knowing yourselves.

Around here people will say no, just put 20% down and put the rest in a index fund.

However sometimes people have this tendency to not put extra cash in an index fund and instead put it in a new car or a remodel or other spending.

That doesn't sound like you though.  I say put 20% down and start maxing your retirement accounts every month (18k each 401k, 5k each Roth).  Then once you feel your cash buffer dwindling down to whatever dollar amount you want your cash buffer to be at, readjust your monthly retirement account contributions accordingly.

Also, I'd recommend using a Roth IRA to save for your child's college fund.  It won't count towards your Expected Family Contribution, and you can withdraw your contributions (but not your gains) penalty free to pay for their college, or better yet, their student loans once they graduate.  I say it's better because these distributions will count as income which affects your EFC for the next year.  That's why it's better to use your stealth stash after the fact to pay for college.  That's my strategy anyways - didn't mean to get too off topic.

YttriumNitrate

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A few years back when I was buying my first house I had enough cash saved to buy the house outright, but decided to just put 20% down to avoid PMI and get the best mortgage rates. Since I bought the house, I've paid about $27,000 in interest that I could have avoided by paying cash. However, the investments that would have been used to buy the house are now worth $230,000 more than when the house was purchased.

Admittedly, this calculation would have been a lot different if I had bought a house in 1999 instead of 2009.

EDIT: Just playing with numbers, had I put down 5% instead of 20%, I would have had an extra $34,000 in investment gains, but there would have had about $8000 in PMI, and an extra ~$10k in interest (higher initial rate, plus questionable refinance when the rates dropped). So, I guess putting 20% down cost me about $16,000...oh well.
« Last Edit: March 01, 2017, 09:25:50 AM by YttriumNitrate »

spooky105

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Yes -- better course of action is to contribute the minimum amount necessary to avoid extra house expenses like PMI (should be 20% down) and start maxing out your tax advantaged retirement accounts, even if that means using some of your cash pile to cover living expenses (real living expenses, not fancy new cars or other "extras").

REASON:  you can only contribute so much to these accounts each year, and you can't go back in time to make up for missed opportunities. Any money you get in the tax-advantaged door will work for you and retain those advantages for the rest of your life, even if you later have to stop contributing. The sooner you start and the more you get in, the better. Also, mathwise your mortgage interest expense (let's assume 4%) is less than the long-term return of equities (6%, 7%, 8% depending on source / future assumptions).

Back of the envelope 2017 tax math:  $90,000 earnings - $12,700 standard deduction - $13,500 personal exemptions (3 people x $4,500) = $63,800 taxable income...this puts you firmly in the 15% tax bracket without considering any other deductions. My personal rule of thumb is any money taxed at 15% goes to my ROTH accounts. I only make TRADITIONAL contributions in years where I have dollars that cross into the 25% bracket (starts at $75,900 for 2017 -- married filing jointly) because I can save $250 per $1,000 in taxable income, but only expect to pay $150 per $1,000 (or less) on any dollars taxed in retirement.

NOTE: another school of thought is to take the TRADITIONAL tax advantage regardless of tax bracket. Thinking goes that you save $150 / $1,000 for most of your taxable dollars while in the 15% bracket, and then pay almost no taxes in retirement -- first $21,700 of withdrawals ($12,700 + $9,000 for a two person household) are tax free and next $18,650 is taxed at 10% before you get back into the 15% bracket. Choice depends a lot on your frugality / life plan -- are you pursuing early retirement in the next few years or trying to get on a better path to a more normalish retirement (maybe still early in your 50s).

ANOTHER NOTE: mortgage interest will only effect these numbers if it + charitable contributions + other itemized deductions exceed the standard deduction of $12,700. The choice there is between taking the standard deduction vs itemizing.

Recommended game plan:

1) Contribute enough to your 401(k) or equivalent to get any employer matches (that's free money -- exact amount will vary) -- go with ROTH if you have the option, but TRADITIONAL may be your only choice depending on employer

2) Max out ROTH IRAs (2x $5,500 = $11,000) -- also max out 2016 IRAs...you have until the taxing filing deadline (18 April) to do this. Would recommend lump sum for 2016 and setting up automatic monthly contributions for 2017 to max the account. Vanguard makes this super easy to do.

3) Max out remaining 401(k) or equivalent balance (2x $18,000 = $36,000) -- assumes you both have access to one.

4) Take a look at what your budget looks like at this point. If after monthly max contributions to 401(k)s and IRAs you are having to tap into quite a bit of your cash pile for core expenses then I would focus on efficiency. Look for ways to trim bills (cut cable, change internet providers/reduced bandwidth, reduce cell-phone data/go with a more cost-effective provider, eat out less, reduce food waste in home cooking, reduce energy consumption, reduce car use, re-evaluate insurance providers/policy deductibles, etc.). $10 in savings on one item is $120 per year. Save $50 per month and now your talking an extra $600 per year. And those savings are more or less forever -- we're about $6,000 richer having cut cable 5 years ago.

5) If the budget still balances then set up contributions to a 529 for kid's college (you can borrow money for college, not retirement) and add taxable retirement investments -- if Colorado has a tax incentive to use their 529 plan then go with that, otherwise use Vanguard.

6) Any surplus from the cash pile (would wait until after closing on the new house/paying moving expenses) that is not needed for expenses in the next 3 years should be invested as one lump sum.

Expect the market to dip at some point and you'll panic. Then remember it doesn't matter because long-term returns are always positive and this is all long-term money. Then go back to living your life.