18

My fiancee and I are shopping for a house, and very fortunate to have the assets to allow us to make a healthy downpayment.

We both like the idea of a lower monthly mortgage payment, specifically the career flexibility that comes with it.

We are looking at houses in the $1.2-1.4MM range, and can put down ~$800K, which delivers a very affordable monthly. After doing so, we'd have ~1.4MM in equities together outside of the house, though about $550K would be locked in retirement accounts.

Question is - are we misguided to make such a large downpayment, even though it buys us some job choices and peace of mind?

  • 1
    Are you planning on staying in that house for a long time? The flipside of career flexibility is sometimes location flexibility. – BrenBarn Nov 6 '15 at 5:27
  • Thanks. We're both happy/have ties to the area, so location flexibility is not as important to us. What we do want is to not feel shackled to our current jobs due to a high mortgage payment. I just want to be sure we're not making a mistake by putting down an extra $500K over the necessary 20%. I love the idea of having a great house at a low monthly, but don't want to regret not having invested the extra $ in the long term. – user34714 Nov 6 '15 at 12:43
  • Not an expert but your questions kinda raises another question for me... is it a better idea to buy a house together when not married, as opposed to married? Right now I'm assuming only one of you is going to apply for the loan...? – unknownprotocol Nov 6 '15 at 21:02
  • @unknownprotocol It is not unusual for only one person to apply for the loan itself if the second person's income isn't needed - sometimes (always?) to add additional applicants. You can also have both names on the deed even if the loan was only applied for in one person's name. – chucksmash Nov 7 '15 at 4:22
  • You might consider what Ric Edelman has to say about the subject. – Tony Nov 7 '15 at 13:40
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Keep in mind, this is a matter of preference, and the answers here are going to give you a look at the choices and the member's view on the positive/negative for each one.

My opinion is to put 20% down (to avoid PMI) if the bank will lend you the full 80%. Then, buy the house, move in, and furnish it. Keep track of your spending for 2 years minimum. It's the anti-budget. Not a list of constraints you have for each category of spending, but a rear-view mirror of what you spend. This will help tell you if, in the new house, you are still saving well beyond that 401(k) and other retirement accounts, or dipping into that large reserve.

At that point, start to think about where kids fit into your plans. People in million dollar homes tend to have child care that's 3-5x the cost the middle class has. (Disclosure - 10 years ago, our's cost $30K/year).

Today, your rate will be about 4%, and federal marginal tax rate of 25%+, meaning a real cost of 3%. Just under the long term inflation rate, 3.2% over the last 100 years. I am 53, and for my childhood right through college, the daily passbook rate was 5%. Long term government debt is also at a record low level. This is the chart for 30 year bonds.

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I'd also suggest you get an understanding of the long term stock market return. Long term, 10%, but with periods as long as 10 years where the return can be negative.

Once you are at that point, 2-3 years in the house, you can look at the pile of cash, and have 3 choices.

  • Choose to pay the mortgage down. This would pull the payoff date to less than 10 years out, as the payment was based on such a high loan. This, in effect, is getting a 4% return on the money, and if that mortgage was bothering you, really takes it to less than half, and much sooner to zero.
  • Take advantage of the rate rise. Not a prediction, but at some point, rates will bounce back. Putting into treasuries or CDs at a rate higher than the 4% you borrowed at would be great.
  • Invest it over time, and get comfortable with the market's volatility. 10%/yr CAGR long term is less attractive to many people than a fixed 4%, guaranteed. This is the fundamental choice you have. Not a recommendation, but an example, DVY, the top Dow Dividend stock ETF, yields 3.28% at this moment. After 15% dividend tax rate, 2.79%. In effect, you are able to invest this money, and for a net cost of .21% get the gains (or loss?) of this ETF over the next decades. In the killer decade of 2000-2009, this 'bad idea' would have cost you 3% (total) of the amount invested. And since then, the market has come back so high, the dividends alone provide a very positive cash flow.

We are in interesting times right now. For much of my life I'd have said the potential positive return wasn't worth the risk, but then the mortgage rate was well above 6-7%. Very different today.

  • Re: "a 4% return on the money": Isn't it really a 3% return, because of the 25% marginal income rate and government subsidy for mortgage payments? – Conrad Meyer Nov 7 '15 at 21:42
  • Paying ones mortgage early is a 4% (in this case) gross, yes, a 3% net. – JTP - Apologise to Monica Nov 7 '15 at 23:17
7

I put about that down on my place.

I could have purchased it for cash, but since my investments were returning more interest than the loan was costing me (much easier to achieve now!), this was one of the safest possible ways of making "leverage" work for me.

I could have put less down and increased the leverage, but tjis was what I felt most comfortable with.

Definitely make enough of a down payment to avoid mortgage insurance. You may want to make enough of a down payment that the bank trusts you to handle your property insurance and taxes yourself rather than insisting on an escrow account and building that into the loan payments; I trust myself to mail the checks on time much more than I trust the bank. Beyond that it's very much a matter of personal preference and what else you might do with the money.

5

Voluntarily assuming a loan is a bad idea, especially for a non-investment purpose. It would be one thing to take on a loan to operate a business or buy a piece of capital equipment, like a machine that would make you money. Borrowing money to have a more luxurious house is foolish.

The smart move is to buy a good quality home that will meet your needs for as little as possible. Having $800,000 leaves a quit a bit of leeway in that department. You don't say where you live, but if this occurred in my area (eastern Massachusetts) I would buy a house for $500,000 and then invest the remaining $300,000. If I lived in the California bay area, it might be necessary to spend the whole $800,000. Either way there should be no need to borrow money. Also, if you buy a house for cash, often you can get a substantially better deal than if you have to involve a bank.

Not owing anyone money is a huge psychological advantage in business and in life in general. View being debt-free as a springboard to success and happiness.

4

Strictly by the numbers, putting more than 20% down is a losing proposition. With interest rates still near all time lows, you're likely able to get a mortgage for less than 4%.

The real rate of a return on the market (subtracting inflation and taxes) is going to be somewhere around 5-6%. So by this math, you'd be best off paying the minimum to get out of PMI, and then investing the remainder in a low fee index fund.

The question becomes how much that 1-2% is worth to you vs how much the job flexibility is worth.

It boils down to your personal risk preference, life conditions, etc. so it is difficult to give good advice. The 1-2% difference in your rate of return is not going to be catastrophic.

Personally, I would run the numbers with your fiance. Build a spreadsheet tracking your estimated net worth under the assumption that you make a 20% down payment and invest the rest. Then hold all other factors equal, and re-build the spreadsheet with the higher down payment. Factor in one of you losing your job for a few years, or one of you taking off for a while to raise the kids.

You can make a judgement call based how the two of you feel about those numbers.

2

I would lean towards making a smaller down payment and hanging onto savings for flexibility.

Questions to think about:

  • Will you still have enough cash to cover 6-12 months of expenses, including the other expenses that come with home ownership? (furniture, fixing stuff that breaks, etc.) It's important to keep enough cash so you're not house-poor for other "life happens" stuff.
  • Do you have an appropriate amount saved for retirement and other medium-to-long term goals? (When will you need a new car, etc.)
  • Are you maxing out other tax-advantaged savings like 401k, IRA etc.? You didn't mention where you live but based on the house price, let's assume you're in a high-tax US coastal city and paying a high marginal rate. So deferring as much tax as possible is a good thing.
  • Are you thinking about kids? If yes, then it's a good idea to hang onto enough cash to max out a 529, which will give you an immediate state income tax deduction plus the gains will be tax-free (like a Roth) when used for education.

If you have enough cash that you can make a huge down payment and still have all the other bases covered, then it comes down to your risk tolerance and personal style. You can almost definitely build a portfolio that will beat your mortgage rate on average over the long term, but with more risk and volatility. Heck, you could make a 20% down payment on another house and rent it out.

1

If you decide you need the extra money, you can always go refinance and get more cash out. At the end of the day, though, if you pay off your house sooner you can invest more of your income sooner; that's just a matter of discipline.

1

Peace of mind is the key to your question. Just before the US housing bust of 2007, I had someone try to convince me to take all the equity from my house which was overvalued in an overheated market. The idea was to put that money in the stock market for a bigger return than the interest on the house.

Many people did that and found themselves out of jobs as the economy crashed. Unfortunately, they couldn't sell their homes because they owed more than they were worth.

I never lost a night of sleep over the money I didn't make in the stock market. I did manage to trade up to a house twice the size by buying another when the housing market bottomed out, but waiting for a market recovery to sell the smaller house.

The outcome of my good fortune is a very nice house with no mortgage worth about 1/3 of my total net worth.

That's probably a larger percentage than most money managers would recommend, but it is steadily decreasing because now, all the money that would go to a mortgage payment instead gets deposited in retirement accounts, and it still has 30 years to grow before I start drawing it down.

I almost don't remember the burden of a mortgage hanging over my head each month. Almost.

  • 2
    +1 although, I think that there's this gray zone on the way to no mortgage. A million dollar home with $200K loan still has a payment to make. I'd rather owe $300K, and have $100K in the bank. So if the 'no job' scenario hits, there's liquidity to carry us over. I'm post-work now, and the timing was fine. Money we saved at 28% marginal rate comes out at sub-2% effective rate. Maxing the 401(k) and IRA deposits was the best move, in hindsight. – JTP - Apologise to Monica Nov 6 '15 at 15:23
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    Yes, liquidity is very important. money.stackexchange.com/questions/29908 – NL - Apologize to Monica Nov 6 '15 at 15:54
1

To answer your precise question, your plans are not at all misguided, and are in fact very reasonable.

You are clearly financially very comfortable, and from the tone of your post it sounds like you value security and simplicity over maximizing your investment return over the coming years. If money was the most important thing to you then you would stay shackled to your high paying jobs.

@JoeTaxpayer's answer has some great information for a person who is interested in maximizing their investment return. If you followed that advice, you might increase your return on investments by up to 1%/year (I'm just throwing a ball park number out there).

So your choice is simple. Peace of mind on one hand and perhaps 1% additional return on investments on the other hand.

  • Great point. Peace of mind is not just a feeling, it is a perception of risk. The higher the equity in the home, the lower the risk. – Ogre Psalm33 Nov 7 '15 at 4:12

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