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My wife and I are saving for a new home in NYC. The only debt we have is a student loan (about $26k left at 3%). We have $47k in the bank and our Household Income (HHI) is about $300k. We owe just under $389k on our current home, on a 30 year mortgage at 4.65%. In the next 2-3 years, we plan on purchasing a new home for our growing family. Does it make sense to make larger principal payments now to have greater equity in our home and lowering our LTV Ratio? Or is it better to have the cash in hand?

While my $$ would be tied up in the house, i feel like there is something to making a large principal payment from a short term ROI perspective. But I am not 100% sure.

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    Why not pay off the student loan? That is a great way to make 3% on your money. – Pete B. Mar 27 '18 at 16:40
  • I've been thinking about it. I've been advised that it is cheap debt, especially with inflation; and I'm better off saving the money. – Parzival Mar 27 '18 at 16:42
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    Where are you getting better than 3% in savings? If you aren't then you are losing money. – Pete B. Mar 27 '18 at 16:45
  • I hear you. My concern there would be not having the $$ for my next home purchase. after the purchase of my new home i plan on attacking the student loan. i'd rather keep the $26k in savings or put it towards my current home to build more equity when I sell – Parzival Mar 27 '18 at 16:53
  • What does "HHI" mean? – Hart CO Mar 27 '18 at 17:03
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Does it make sense to make larger principal payments now ... ?

Yes, it does, with a few caveats:

  1. Prior to the new tax law, your effective interest rate on your mortgage would have been lower than 3%, which means it would have been better to payoff the student loan before the mortgage. But now with the new tax law you will still be able to itemize, but probably not by enough to bring down the effective mortgage rate to below 3%. An exception to this would be if you donate a lot of money to charity, or have large medical expenses. One way to think about this is if you can itemize in 2018 before considering your mortgage interest, then you should pay off the student loan first.
  2. If there is a possibility that you will close on your new home before selling your current home, you will want to maximize the amount of cash on hand to make sure you avoid PMI and reduce the cost of the NYC mortgage tax.

Based on your situation I would guess that you will sell your home prior to closing on your new home so you'll get that equity back right away. Just make sure you have enough cash on hand to pay for moving expenses and other misc closing costs that occur before you sell your existing home.

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I think your assessment is right, for short-term benefit I am not aware of any savings vehicles that will come anywhere near that 4.65% savings you'll realize by making extra principal payments.

If you imagine trying to buy/sell simultaneously, having more equity instead of a cash down payment means you'll be making offers contingent on the sale of your house, which are less attractive and could make buying more difficult (likely not a huge issue, contingent offers are very common). Likewise, if you predict it will be a seller's market in NYC in 2-3 years and think you may have difficulty buying a house (if you're quite particular and don't see many appealing houses on the market at any given time), then it could be advantageous to save up a 20% down payment and forego the interest savings from extra principal payments. That way you have more flexibility on timing your purchase and aren't rushed on a home decision.

Alternatively you could just sell first and plan on living in an intermediate house while finding a place to buy, or sell with a leaseback which could give you an extra 60 days to find a place to buy (could still get tight on timing).

If you're easier going and find many places agreeable, then buying/selling simultaneously shouldn't be too big of an issue.

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The wisest course would be to get the student loan paid off now, and use that payment plus any residual income to start saving like crazy for the new house. You want to have at least a 20% down payment to avoid PMI, and getting rid of the student loan will reduce your debt-to-income ratio, improving your ability to get a new mortgage.

If you plan to sell in the next few years, you would be better off NOT putting extra down toward the mortgage, and instead use that cash to save for the new house. Also, don't put the savings in anything other than a risk-free savings account (or possible a CD), or you risk losing some of it by the time you are ready yo buy a house (the risk that the market declines in a 2-year period is significant).

One factor you didn't mention is how much equity you have in the current house. That equity can be used to increase your down payment, but it will require that your purchase in contingent on the closing of the old house, which can complicate the timing of the transactions.

If you can get to 20% with the equity in the house and are comfortable making the sale contingent, then you can save a little interest by putting extra towards the mortgage, but I would not do it if it's going to put your down payment below 20%.

  • Wow, usually we are pretty much aligned, but this time our answers are almost the exact opposite of each other, though I think both are good advice. :) – TTT Mar 27 '18 at 18:25
  • @TTT My gut tells me that the down payment is the biggest rock in this situation, but after reading your answer I added a caveat as well :) – D Stanley Mar 27 '18 at 18:27
  • That, and will they sell before buying? – TTT Mar 27 '18 at 18:29
  • yes, we'd have to sell before buying. so either a contingency offer or selling first before putting an offer on a new home. Luckily for us, "starter homes" sell pretty quickly in NYC. – Parzival Mar 27 '18 at 18:39

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