Invest the house?

June 19, 2008 7:35 AM

$75,000 to invest. Question: Do we put it down on our next house or invest for retirement?

We (finally) just sold a house one of us brought to our marriage. We have paid off debt with the profits, are planning a family vacation, and need to decide what to do with the rest of the money. DH and I find ourselves in some disagreement about this. We've consulted with a financial planner/investment guy, but I have hesitation about his advice, so want to do some more research before we meet with him again. I'll give you more details here not because I expect the mefites to do our financial planning for us, but because I am new to this, and need to know which general direction to go.

The stats: We both are public employees in a relatively stable (knock on wood) public employee retirement system (Oregon). I have been there 14 years, DH has about 11 years in. We could retire at 54 and 60 respectively with full pensions (30 years in).

We currently contribute $500 a month to deferred compensation plans, that are pre-tax investments. We plan on upping that now that we've reduced debt payments, and could add another $500 without a problem. We've accumulated about $80K in various investments, in these accounts and in an old IRA DH has.

We have 2 children, 2 and 11, so college planning is important-we haven't done any saving here, though my folks have some-but we don't intend to pay all college costs.

We own the house we live in, with about $80 K in equity. We really do need to move-not a great neighborhood, house too small for us and all of our crap, and we'd like to live somewhere where we aren't so dependent on cars. We'd like our next move to be our last, as much as possible; a house that we can live in long term. We'd plan to get a 15 year mortgage so we could be free of it at retirement.

Question at hand: Our adviser believes strongly that it's better to take out a larger mortgage and use your cash to invest; that it will give you a better return over time, and, if you're not planning on selling your house, the return you get in property is irrelevant, since it's not money you have to spend. He advised friends of ours, with a lot of equity in their house, to take equity out to invest a year or so ago. They are, obviously, very glad they didn't.

This philosophy makes me really, really anxious. My preference would be to put the money down on our next house, continue investing, and increase our investments as our income increases and our mortgage stays the same. I like the idea of being less on the hook as far as mandatory monthly payments. It's also a good time to buy real estate (though probably a crap time to sell the house we're living in). Drawback, of course, is a smaller tax deduction this way.

DH is worried that we might not have enough for retirement. I am pretty blase about it and think we're doing well.

What's your advice? Any great website to help us way the pros and cons?

posted by purenitrous to work & money (21 comments total)

If you invested the $80k, will you still be able to make a suitable downpayment on your next house?
posted by mullacc at 7:49 AM on June 19, 2008

What about putting 20% down on the new house and investing the remainder. This way you won't have pmi, you will qualify for the best rate possible at your risk level, and should have a decent amount leftover to invest.
posted by curlyelk at 7:52 AM on June 19, 2008

My preference would be the same as yours. With the lower mortgage payment, you can put as much as you're comfortable with into your retirement accounts.

As for the mortgage interest tax deduction, that's sort of a false benefit. You only get back a small percentage of the money you're paying toward interest. I think paying less interest overall is a much better goal.

Another thing to consider is the tax benefit of your current retirement accounts. Both 401(k)s and IRAs have some tax benefits, but they also have contribution limits. You couldn't plop that whole amount into either of those accounts all at once. You could put it into a regular mutual fund, but the money would be taxed going in and coming out.

Would splitting it up be an OK compromise? $30k to retirement, $30k toward your next house, $15k to college fund, or whatever proportions make you both happy.
posted by boomchicka at 7:58 AM on June 19, 2008

I have yet to encounter a tax deduction large enough to justify a dubious financial proposition.
posted by fantabulous timewaster at 7:58 AM on June 19, 2008

Put $10k of it into solar energy stocks and other sustainable energy investments. Doing that now would be like investing in Microsoft, Cisco, etc in 1992.

The reason I say $10 is that putting a smaller amount of money into a higher risk/reward investment is similar to putting all of your money into a 'safer' bet. But this way you'll never have to worry about losing more then $10k.

Check out these returns over the past year on two solar stocks.

That's not long term advice, but I've been making money hand over first for the past few days so it's kind of exciting right now :P
posted by delmoi at 8:04 AM on June 19, 2008 [1 favorite]

two points: consider the fat wallet forums. those guys LIVE for these kind of questions.

also: could you live with waiting another year or perhaps two before making the decision to purchase another home, if only because we don't know when exactly the current downturn will bottom out? nobody likes to overpay...
posted by krautland at 8:06 AM on June 19, 2008

I was in pretty much your position a couple years ago. Sold my old house for a nice profit.

A 15-year mortgage is about 6% right now. If you can invest and reliably get returns of more than 6%, you're coming out ahead—and you probably can. Even a 1% difference over 15 years will be significant.

Obviously different people have different priorities and different levels of comfort with risk, but if you approach it in terms of maximizing income, your financial planner is right.
posted by adamrice at 8:13 AM on June 19, 2008

Our adviser believes strongly that it's better to take out a larger mortgage and use your cash to invest

I agree with your adviser. Home mortgage is the last great government aid program for the middle class. The interest is tax deductible so that knocks something like 30% or more off the effective interest depending upon your total incremental tax rate (the rate you pay on the last dollar earned). This means the loan costs you four something percent. It should be pretty easy to beat that long term, even without taking much risk.
posted by caddis at 8:41 AM on June 19, 2008

I would find a different financial adviser, one who doesn't promote the idea of the maximum mortgage size. Look how poorly his advice has been for those people today who are going into foreclosure because their mortgages are upside down with negative equity. People vastly overestimate the mortgage tax deduction. Remember that you give up $10,500 of the standard deduction when you itemize. As a result, the actual interest deduction is far less than the 30% that caddis claims. Paying down a mortgage is a riskless investment and you have to compare alternative riskless investments. You can get less than 4% today on treasury bonds.

Put at least a 20% down payment on your new home to get a better rate and no PMI. One of the best investments you can make is to your retirement plans (deferred compensation and IRAs), assuming the plans have reasonably good mutual funds with low expenses. You should not put more into a house down payment as long as both of you have not maxed out your deferred compensation plans and your Roth IRAs. Any money left over from your down payment should be used to live on so that you can put the maximum of your salaries into your retirement plans for the next few years. Retirement plans grow tax free for the rest of your life. If you aren't putting in the maximum each year, you have given up some of that benefit and cannot make it up in subsequent years.

You might also consider a 529 plan for your kids education. A 529 plan is like a Roth IRA for your kids. Money goes in after-tax but accumulates and is withdrawn tax free.
posted by JackFlash at 9:07 AM on June 19, 2008

Put $10k of it into solar energy stocks and other sustainable energy investments. Doing that now would be like investing in Microsoft, Cisco, etc in 1992.

I think this isn't good advice, given the background in the question. Telling somebody who says "This philosophy makes me really, really anxious.", that they should invest a significant sum in a small (and volatile) sector of the market, is like forcing an acrophobe on to a vomit comet.

There are two sides to any personal finance question - the numbers and the psychology. Both are equally important. Yes, it might make more sense to invest the money instead of reducing the debt load, over the long term. If somebody is risk-averse, however, then paying down debt and minimizing the ongoing payments will be the best option for that person.

Honestly, if investing the wad makes you nervous, then either pour all of it into the house and keep the mortgage to a minimum, or put most of it into the house and invest a relatively small portion in a broad-based index.
posted by gwenzel at 9:58 AM on June 19, 2008

Agreed... put it all into an index fund, or if you want to actively manage it spread it around some well performing mutuals and change em up every year.
posted by fusinski at 10:06 AM on June 19, 2008

I would find a different financial adviser, one who doesn't promote the idea of the maximum mortgage size. Look how poorly his advice has been for those people today who are going into foreclosure because their mortgages are upside down with negative equity.

Although I'm not a big fan of doing this either, to be fair the vast majority of the people who are going into foreclosure did not get there by investing in the stock market. If you invested in overall stock market 1 year ago, you lost around 13% of your investment. Meanwhile the median home sales price has dropped around 8% over the last year.

Let's say a year ago you had a house worth $300k, so it would be worth around $275k now. If you only had $30k in equity (10% of the total value) a year ago then you could have taken that entire amount and invested it in the stock market without getting into big trouble. Today you would still have $26k of the original equity left over, which would by itself be enough to make up the loss from falling home prices and keep the mortgage above water, without even considering that you would have built up more equity over that year by making your monthly mortgage payments.

It's much more likely that the people facing forclosure bought mortgages that they could not afford the payments on, used the equity to to buy things/pay off debts, or never put much equity into the home in the first place. With that said I still agree that keeping at least 20% of your home's value in equity is a good idea.
posted by burnmp3s at 10:37 AM on June 19, 2008

In the 6 years I've owned my house, it's never made financial sense to take the mortgage interest deduction. We just don't have enough else to make up the difference. So that's definitely something to take into consideration. (We also don't have kids, so that may be part of the Your Mileage that May Vary.)

If it were me? I'd put a good chunk (the max?) into 529s or something similar, to help the kids start out their adult lives w/out debt, and then put most of it into the house down payment. I just like the idea of getting that house payment as low as possible, since for me at least, that's one of the biggest month-to-month expenses I've got!

It seems to me like you're on a good target for retirement savings, but I did rustle up a couple of calculators:

* Vanguard
* Yahoo! Finance

That might help you figure out at least whether you're in the ballpark in that aspect.
posted by epersonae at 10:51 AM on June 19, 2008

We've consulted with a financial planner/investment guy, but I have hesitation about his advice, [...] This philosophy makes me really, really anxious. [...] He advised friends of ours, with a lot of equity in their house, to take equity out to invest a year or so ago. They are, obviously, very glad they didn't. [...] I am new to this, and need to know which general direction to go.

You should go in the direction of a financial advisor you feel able to trust. No point in paying for advice you don't trust enough to follow.
posted by Mike1024 at 11:51 AM on June 19, 2008

I would find a different financial adviser, one who doesn't promote the idea of the maximum mortgage size. Look how poorly his advice has been for those people today who are going into foreclosure because their mortgages are upside down with negative equity.

They would have lost that money either way, the only difference is, they would have kept the interest they earned.
posted by delmoi at 12:18 PM on June 19, 2008

Experts debate this topic all the time (google search). For me, the psychological effects of ending my mortgage payments are greater than the financial impact of investing that money. That being said, I also max fund all of my retirement options, adequately fund my kid's 529, carry no debt and have a 12 month reserve that would maintain my current lifestyle. Not to mention I have a long period of compounding interest ahead of me. In the end, I think this is going to be a highly personal decision but it appears the rational decision is to invest the money in one way or another.
posted by toomuch at 12:33 PM on June 19, 2008

Your advisor is correct in financial terms but for your own piece of mind it might be better not to take their advice if doing so will make you anxious.

You sound risk averse and investing in your next house is risk free. You would however as other people have explained in this thread be able to get a better return on your investment by not doing that.
posted by electricinca at 1:33 PM on June 19, 2008

The interest is tax deductible so that knocks something like 30% or more off the effective interest depending upon your total incremental tax rate (the rate you pay on the last dollar earned). This means the loan costs you four something percent.

Except that interest and dividends and capital gains on the money that you invest is also taxable, so the tax arbitrage that one gets from levering in one place by investing in another is often minimized.

Anyway, to a first approximation you'll want to compare the tax-effective return of your mortgage versus the tax-effective return of whatever it is that you would invest in. Because making the tax adjustment isn't straightforward (unless you are fully committed to buying and holding a specific investment for a set period) and the return itself of anything variable (that is, anything other than the mortgage or a held-to-maturity debt instrument) is also unknown, you're probably best off modeling the whole thing in Excel under a number of different assumptions. Which is precisely what one pays a financial advisor to do. If your FA cannot do this, then you maybe shouldn't be paying him or her.
posted by Kwantsar at 1:51 PM on June 19, 2008

If I were in your situation, I'd put 20% down and only get as much mortgage as you'd be comfortable paying independent of how much money would be left over. Yes the tax deduction is great, and yes the stock market has better historical returns than real estate but I think you need to make your decision on the house independent of the amount you'd have left over to invest. If you need to put down 30% to have a comfortable mortgage, you can always take the difference each month and invest that.

Another option is to talk to other financial planners and get their opinions as well. It's like hiring a home improvement contractor, talk to as many people as you reasonably can because each will have their own biases and beliefs based on their experience.

Good luck.
posted by wangarific at 2:04 PM on June 19, 2008

If i had $75K I'd buy as much rental property as I could that still allowed the rents to cover the mortgage + a few percent. If you can get a duplex or a fourplex with a 15 or 20 year mortgage, you could retire with a monthly income of several thousand dollars that was in no way tied to your home property. They are giving property away around here: places that rent for $1200/ mo are selling for $100K+.
posted by fshgrl at 5:52 PM on June 19, 2008

I wouldn't put down more than 25% of my money into a new house on a mortgage. Look at how much the market has dropped in some markets (50% in some areas of California!). If you need money in a hurry, trying to get the money you invested into your home in equity is almost near impossible to get back if the house market is in the shape it's in now. Your friends who would have taken equity out of their mortgage are the example here. Their mortgage payment would still the same, but now they would have additional payments they have to make (the minimum payment) just to get the money back into the house. If the money was from investments, well there's nothing to pay back when they take the money out of the investment.

If you get a mortgage, those payments near the end won't feel bad at all, because inflation and rise in your personal income will make those bills in 15 or 20 years seem much smaller.

I wouldn't put all the money in one place, but definitely would split it up between several different investment vehicles (annuities are good for risk averse investors for a small portion of your portfolio for mid term investments, mutual funds, etc.)

Definitely talk to another financial planner. If you're hearing the same thing from two different types of planners, they might be on to something.
posted by inthe80s at 6:21 AM on June 20, 2008