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I am 23 with no debt and planning on purchasing a house. I've been running through many hypotheticals and decided to post an example to see what others think since this is a significant decision. I am looking at a $200k home, conventional, and currently have $40k (20%). I am considering leaving $10k of that $40k separate for a small emergency fund and other expenses (closing costs, inspection, etc.). Assume I have $500 each month to put towards extra principal on mortage or mutual funds.

Option 1: If I put most of the money towards down payment, e.g. $30k (15%), I am significantly close towards removing PMI (~$75/month), and have less interest to pay per month (~$60/month less, based on 3.5% interest rate).

Option 2: If I put part of the money towards down payment, e.g. $10k (5%), I can place part into mutual funds, e.g. $20k, and be earning money on that ($133.33/month, avg based on 8% return in 1 year / 12 months).

Is option 2 the way to go? How do taxes from mortgage/investing play a role and do they make a dent in either option? Since this is a significant purchase, is there anything I've overlooked?

This question from 2011 resembles what I've put here, but I have never invested nor know the costs and taxes associated with investing (though I have read up a bit on stocks and mutual funds).

  • joetaxpayer.com/crazy-truth-about-pmi should scare you straight about PMI. – JTP - Apologise to Monica Nov 16 '14 at 4:46
  • @JoeTaxpayer Using a worst case scenario of $125/month (Conventional PMI, not FHA), that results in an extra 0.8% per year (essentially making the interest rate 4.3% for up to 3 years and reverting back to 3.5% thereafter). Ideally, I would be making that up via investment returns. – BLaZuRE Nov 16 '14 at 5:13
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    I suggest you read the article I linked to. the .8% is on the entire balance, $170K (say) but it's because you are not putting the extra $10K down. The effective rate is 18%. – JTP - Apologise to Monica Nov 16 '14 at 13:11
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I concur that you should probably go with option 1. And that is coming from a guy that refinanced all three of his properties with down to 20% equity 3 years ago to lock in either 4% 30 year fixed or 2.75% 15 year mortgage. And I will not pay them off early because I do think I can do better than that in the market even if inflation is 0% for the next 30 years. Just imagine when the fed stops manipulating tax rates. I could be making more than 4% just in a checking account.

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For Option 2 - do you really think you can guarantee an average return of 8% here. Historical returns are no guarantee of future returns.

Even if you could get higher returns for option 2 than the interest rate on the mortgage, are you able to cover all the additional fees with the PMI in placing such a low down payment?

The wiser choice in my opinion would be to chose option 1.

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