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I am buying a home in the U.S. and getting a 30yr fixed loan @ 3.25% interest rate. I would like to know if I should put down as much money as possible, or if I would be better off making minimum downpayment and invest the rest of the money elsewhere (but where?) Additional Info:

  • don't want to invest this money in a retirement account. Already have a retirement account to which I contribute monthly.
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Define the range of down payments you are considering. Are you willing to pay PMI each month? Or is the range between no down payment and low down payment? –  mhoran_psprep Oct 14 '12 at 17:16
    
currently am putting 40% down. Can pay PMI - it all depends, if the money can be invested elsewhere such that rate of return (tax adjusted) beats the mortgage interest rate. –  morpheus Oct 14 '12 at 18:09
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3 Answers

up vote 5 down vote accepted

As weird as it seems, 5 years is not a long term investment. Furthermore investing is about accepting risk. Based on your criteria for the alternative to a down payment, I think your only choice is to make the larger down payment.

However

If however, you were willing to invest that money for the long term (in a retirement account or an educational account for example) then I would definitely encourage you to invest. I think the chance that a long term investment in a diversified investment account will exceed 3.25% is pretty high. However, that is only my opinion, and I am not clairvoyant, so your let your personal tolerance to risk be your guide.

In summary

But again, based on the way you asked it, down payment all the way. Your time frame means you are not an investor. Therefore your only option for risk free storage of money is an FDIC insured account, which might pay a little less than 1% for the next 5 years. A bigger down payment will have a 3.25% return in this case.

Also, make sure the following is true:

  1. Taking any match available at work via a 401K
  2. No unsecured debt (like credit cards) or bad debt (high interest car loans or student loans)
  3. A fully funded emergency fund that is 6 months of your expenses. Especially important if you own a house.
  4. Pay off any other loan (student loan, car payments or peronal debt)
  5. Maxing out a Roth IRA if you are eligable
  6. Maxing out a Traditional IRA
  7. Spending some of your money to have fun.

In that order. #4 and #5 could be swapped if the interest rate on the loans is really low.

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made some edits to my question, in response to your answer. –  morpheus Oct 14 '12 at 18:07
    
Okie doke. I updated my answer. The basics are the same because your time frame is so short. Congratulations by the way. Sounds like you make good choices with money. –  MrChrister Oct 14 '12 at 19:00
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I like the list. I'd put 3 at the first position, and 5/6 really depend on the specifics of the investor, current bracket, potential future bracket. –  JoeTaxpayer Oct 15 '12 at 1:24
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If you don't want to take any risk and you want your money to be liquid, then the best place to "invest" such money is in an insured bank deposit, such as a high interest savings account.

However, you aren't likely to find a savings account interest rate that comes close to that charged by your mortgage, so the better decision from a numbers perspective is to pay down more on your mortgage or other debt. Paying down your debt has almost no risk, but has a better payoff than simply saving the money in a bank account.

However, if you choose to pay down more debt, I suggest you still keep aside enough cash to have an adequate emergency fund. Since you want safety and liquidity, don't expect high returns from such money.

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Morpheus, I think you are approaching this question the wrong way. The interest rate is not the most important consideration; you also need to consider the other characteristics of the investment. Money in a bank account is very liquid; you can do anything you want with it. Equity in a house is very illiquid; it is hard and expensive to access.

Let's say you have $25,000 to either go towards a bigger downpayment or to invest. What happens if you lose your job? If you have $25,000 in the bank, you have a lot of flexibility; you can pay a mortgage for a number of months, or you could use it to relocate. If you put the money in the house, you cannot access it at all; without a job you can't refi or get a home equity loan. Your only recourse would be to sell the house, which might not be possible if there are systemic issues (such as the ones in the real estate crash). Even if you can refi or get a home equity loan, you will have to pay fees.

My advice is to put the money somewhere else. If your term is long (say, 10 years or so), I would put the money in an index fund.

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thanks for the answer. I have already established an emergency fund for 6 months. The question is what to do with rest of the money. Is there an index fund that is guaranteed to return 4.25% or more in 5 years? –  morpheus Oct 15 '12 at 17:09
    
There aren't any guarantees in investing. The money you earn in interest represents payoff to the risk you are taking. –  MrChrister Oct 17 '12 at 4:38
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