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Let's say I have 500k in cash and would like to buy a 750k house. My burn rate (monthly spending) is around 4k per month, my income around 8k per month (after taxes, not including IRA contributions). My questions:

  1. How much should my down payment be?
  2. How much should I keep in my emergency fund?
  3. How long should my mortgage be?

I understand there is no one-fits-all answer. I'm looking for personal advice, or general rules of thumb.

  • Does your current 4K burn rate include housing costs (rent, utilities, etc)? Although you did not indicate a currency denomination, I assume this is US by your mention of an IRA? – Rick Goldstein Oct 28 '14 at 4:44
  • @RickGoldstein The 4k / month does not including housing costs (rent, utilities). If you add all that my burn rate would be 5k / month. – brt Oct 28 '14 at 6:01
  • @RickGoldstein Yes, we're talking about US Dollars. – brt Oct 28 '14 at 6:02
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    What state and county do you live in? (This will have an effect on loan limits.) – Nathan L Oct 28 '14 at 15:07
  • @NathanL Either WA or CA – brt Oct 29 '14 at 1:06
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I'm going to answer your questions out of order.

Emergency fund: Depending on how conservative you are and how much insurance you have, you may want anywhere from 3-12 months of your expenses on hand. I like to keep 6 months worth liquid in a "high-yield" savings account. For your current expenses that would be $24k, but when this transaction completes, you will have a mortgage payment (which usually includes home-owners insurance and property taxes in addition to your other expenses) so a conservative guess might be an additional $3k/month, or a total of $42k for six months of expenses. So $40-$100k for an emergency fund depending on how conservative you are personally.

Down payment: You should pay no less than 20% down ($150k) on a loan that size, particularly since you can afford it. My own philosophy is to pay as much as I can and pay the loan off as soon as possible, but there are valid reasons not to do that. If you can get a higher rate of return from that money invested elsewhere you may wish to keep a mortgage longer and invest the other money elsewhere.

Mortgage term: A 15-year loan will generally get you the best interest rate available. If you paid $400k down, financing $350k at a 3.5% rate, your payment would be about $2500 on a 15-year loan. That doesn't include property taxes and home-owners insurance, but without knowing precisely where you live, I have no idea whether those would keep you inside the $3000 of additional monthly home expenses I mentioned above when discussing the emergency fund.

That's how I would divide it up. I'd also pay more than the $2500 toward the mortgage if I could afford to, though I've always made that decision on a monthly basis when drawing up the budget for the next month.

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    +1 for the down payment number. You didn't mention this specifically (but I assume it is driving your choice of number), so I'll add that 20% is typically the minimum amount you must put down to avoid PMI. And paying for a bank to have an insurance policy is, IMO, one of the worst ways to spend one's money. – Wesley Marshall May 8 '17 at 23:18
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Mortgage qualification is typically done based on pretax income. To keep the math easy, let's assume $10K/month gross.

A well written loan allows 28% or $2800 to be used for the mortgage and property tax. Property tax varies, but 1% is the average of the 2 states mentioned. This results in $7500/yr property or $625/mo tax leaving $2175/mo. Note here - OP stated $750K house.

$2175 will finance $450K at 4%/30 years.

$2175 will finance $300K at 3.5% /15years.

Let me pause here. Facts are most important to make these decisions. Unless you're clear on gross income, which may be higher, the constraints above quickly come into play.

Once the numbers are spelled out, you may find that you are qualified to only borrow $350K based on a 30 year note. Nathan's $2500 payment was correct, but for the mortgage only. Add property tax and you'd be at $3125. You'd need a gross $11,160/mo. to meet the 28% rule.

The above discussion would render any further thoughts (of mine) moot.

  • Where are you getting your $1000 a month property tax figure from? That is ridiculously high – James Wierzba May 8 '17 at 19:01
  • My own property tax is about 1.6% of assessed value. 1.5 seems to be typical in my area. Of course for any answers like this that include numbers one should adjust up or down depending on the situation they are in. – JoeTaxpayer May 8 '17 at 20:06
  • Yes but that is per year right? In your answer you have it as a monthly rate – James Wierzba May 8 '17 at 20:43
  • @JamesWierzba - In hindsight, I ignored that OP mentions 2 states, closer to 1% tax rates for property. I adjusted number accordingly. – JoeTaxpayer May 8 '17 at 20:51
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As observed, there is no answer that will fit all, but below are some considerations:

  1. Your monthly requirement is 5000, so you have 3000 left to pay the monthly instalments (EMI). However, if you do pay 3000, you will have no money left for any other activities (holidays etc.) till your EMI is finished

  2. Set off a sum, let us say 500-1000, per month (you shall have to decide), for other expenses

  3. The rest of the money, in this case 2000-2500, you can pay as monthly EMI

  4. If you indicate that your monthly EMI to the bank, they will be able to tell you how much of loan you are eligible for and for how long the EMI would last. This is your benchmark

  5. If this loan amount is 750,000 or more, you do not need to put in your own money. So the decision then becomes how fast you want to pay off your loan and as accordingly you shall utilize your 500,000

  6. However, if the EMI will not cover a loan of 750,000 (more likely case), you have options between the following:

    a. Max out on your loan that 2000-2500 EMI/month (in terms of years as well as amount) can get you and put the rest from 500,000.
    b. Min your loan in terms of amount and time and put your entire 500,000
    c. The middle ground is to balance between the loan and your own money, which is the best approach, there is no figure here that works for all, you have to take the decision based on your circumstances. However, in general, the shorter the loan term (in years) better it is as in aggregate you pay less money to the bank.

If you are 1-2 months away from buying the house, one exercise you could do is to keep the EMI money in a separate bank account and see how you fare with the residual cash, this would give you a good reality check.

Hope this helps, thanks

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  1. A down-payment does not help you at all. It's to reassure the bank that you will keep making payments. You will pay 3%-4% on the principal, and any money you don't put down is money you can put into index funds and get 5%-10% on. If the bank will accept 0% down (one lender would lend out 105% -- until it collapsed) under terms you find acceptable, that's all good on your side.
  2. I wouldn't buy a house unless I could make payments for at least 3 months even if I lost my job. It's just not worth the risk of foreclosure. Better to rent until I can build up a war-chest.
  3. A shorter mortgage doesn't help you at all. The length of the mortgage just sets a minimum you must pay every month. If you want to pay so much that you are paid off in half that time, it's up to you. Like a 0% down-payment, if the bank will give you a 100-year mortgage, take it.

The reason to put more money down or accept a shorter maximum term is because the bank sweetens the deal (or fails to sour it in some fashion). For example, typically, if there is less than 20% down, you have to pay an premium called "Private Mortgage Insurance", which makes it bad deal.

But I see banks offering the same rate for a 15%-year mortgage as for a 30-year one, and I think: fools and their money. Take the 30-year and, if you feel like it pay more every month. Although why you would feel like it, I don't know, since it's very difficult to get that money back if you need it.

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    "A longer mortgage doesn't help you at all." It does, I think, by giving you flexibility if/when an "issue" comes up where you can't pay what would be the 15 year payment. – RonJohn May 9 '17 at 3:09
  • @RonJohn -- eek. That's a typo. Corrected now. – Malvolio May 9 '17 at 18:30
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How much should my down payment be? Ideally 20% of the purchase price because with 20% of the purchase price, you don't have to pay a costly private mortgage insurance (PMI). If you don't have 20% down and come across a good property to purchase, it is still a good idea to go forward with purchasing with what you are comfortable with, because renting long term is generally never a good idea if you want to build wealth and become financially independent.

How much should I keep in my emergency fund? People say 3-12 months of living expenses. Keep in mind though, in most cases, if you lose your job, you are entitled to unemployment benefits from the government.

How long should my mortgage be? 30 year amortization is the best. You can always opt to pay more each month. But having that leverage with a 30 year loan can allow you to invest your savings in other opportunities, which can yield more than mortgage interest.

Best of luck!

  • Never buy PMI on your mortgage. If you only have 5% down, get an 80% mortgage with no PMI and a 15% second mortgage, which will have a slightly higher rate, but nothing compared to the absurd PMI costs. If your mortgage broker does not suggest this to you, find a better broker. – Malvolio Mar 22 '17 at 23:46
  • Where I live, unemployment insurance is pretty meager ($247/week). – RonJohn May 9 '17 at 3:11

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