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Background: I am married with no kids (but anticipating them at some point) and no debt at all. My spouse and I have an emergency fund, both fully fund our retirement accounts, and are also keenly interested in long-term investment. We current rent a small apartment as inexpensively as possible but are looking to purchase a house in our high cost of living area. Our down payment will be at least 20% of any house we would consider purchasing for the sake of our own comfort level with debt and monthly costs. Our down payment fund includes extra to cover closing costs completely.

Question: Given that we have fully funded a down payment we are comfortable with, should we allocate additional savings from the point that the down payment is funded towards making that down payment larger or move on to long term savings (we're thinking of investing in an S&P 500 or total market index fund) that could later be used to pay things such as future kids' college educations or add to our retirement?

In favor of investing, we see:

  1. While rising, mortgage rates are still relatively low and the return on investment in an index fund is likely to be higher
  2. The stock market, while rising, is cheaper to invest in now than it was at its peak. There are worse times to get in the market, especially since this investment would be intended to be held quite long term.
  3. You can't gain back compound interest you didn't earn, so starting early helps.
  4. Low rates right now mean savings accounts, etc. are really not performing in any significant way

In favor of amping up the down payment, we see:

  1. Total lower monthly cost on the mortgage means we'll have more money for covering the cost of future children as they grow. It also means we can potentially save more each month in the future
  2. Total lower monthly cost makes it less likely that, if some dire financial situation hits, we'll have problems with our mortgage.

What are we missing?

  • You can't get back compound interest that you're charged on your mortgage, either. Then again, that stuff is generally taxed differently too. – user296 Feb 11 '11 at 16:19
  • @fennec - besides the tax benefits with mortgage interest (which I chose not to factor in due to their debated nature - they'll be a bonus based on our estimated budgets), I figure the average return on the S&P 500 is way better than current mortgage rates, but you make a good point. – justkt Feb 11 '11 at 16:21
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There are two components to any non-trivial financial decision:

  1. Impact on wealth
  2. Impose on cash flow

Assuming that all things remain equal, borrowing money at a low rate while investing for a higher return is a no-brainer. The problem is, all things do not remain equal. For example:

  • Jobs change or end
  • Children get born
  • Cars break
  • Real estate markets swing
  • Interest rates go up

I think that you need to assess your position and preferences. I'd err on the side of being in less debt.

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One thing that's often overlooked is that cash reserves are also a long-term investment. Anything can be a long-term investment if it's expected to appreciate or pay interest/dividends. So it's not either/or. Stocks are but one way to do long-term investments.

Having said that, taking on less debt for a consumer good is never a bad idea. Your primary residence is a consumer good, regardless of those who would say that "your home is your biggest investment." So, there's my vote for a larger down-payment.

Beyond that, a couple of outside-the-box comments:

  1. You should shop around a lot. There is a lot of bank-owned inventory that has not hit the market yet, because if it were all to hit the market at once, prices would tank. There are still a lot of adjustable-rate mortgages that are left to reset. Prices and opportunities will get better for a while.
  2. You mention that you're in a high cost-of-living area. Is moving a consideration? The money that you've saved up would buy a larger down-payment in a lower cost-of-living area.
  • we'd like to move to a low-cost area, but one of our industries is tied to our area, so it would require a career change. Our area is also rather low in foreclosures. – justkt Feb 14 '11 at 13:12
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I'd put the 20% down, close on the house, live in it for a year, and save the difference. If you find your cash flow is fine, run a calculation and start on a program of prepaying a bit of principal each month as an extra payment. If you study how amortization works, you'll understand that an extra payment of about 1/6 the amount due will knock off a full payment at the end. This is how a 30 year mortgage starts out.

Meanwhile, you should keep in mind, it's easy to prepay the mortgage, but there's really no getting it back. So, before letting go of your money, I'd do a few things;

  • Fund your 401(k) account to get the full match if any.
  • Fund IRAs
  • Top off the 401(k) accounts
  • Keep all other debt at zero
  • Have an emergency fund
  • Have funds available so if you or the wife are out of work, you can convert from 401(k) or traditional IRA to Roth and pay the tax due (at the lower rate you'd be in)

I may be stating the obvious, but consider - No matter how low the payment on your mortgage, a payment is due each and every month until it's paid off. You put 80% down, take a 10 year mortgage, you still have payments for 10 years. You want to insure yourself against needing to sell in a hurry if you both lose your jobs, so whatever you put down, I'd recommend a healthy emergency account, 9-12 months worth of expenses.

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Every payment you make on your house will already be increasing your equity in it. For that reason alone, I'd recommend moving additional savings into other long-term funds.

  • At the same time, every payment will also include interest, insurance (which will be higher than my current renters insurance), and tax that I will never get back. Rent rations in my area, while not so high that I should never buy, are still somewhat high. – justkt Feb 11 '11 at 17:38
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Another vote for a bigger downpayment, for the reasons Benjamin mentions.

Also, from experience, I would save up at least a small pile as a separate house emergency fund because you will find things that are wrong and/or that got bodged by the previous owner and it's probably not going to last past the first few months of home ownership.

In my case, the home inspector missed - amongst other things - that the shower on the 2nd floor was leaking both into the adjoining bedroom and the living room below. That added a little unexpected expenditure as you might guess.

  • good point on the additional pile for home repairs. I've read 1-2% and saved accordingly, but didn't mention it. – justkt Feb 11 '11 at 19:06
  • @justkt - I would initially save up more, the 1%-2% are usually mentioned for maintenance but a home someone sells is often not in pristine condition and might need some repair. – Timo Geusch Feb 11 '11 at 19:20

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