Ideal down payment for new house
March 19, 2011 11:32 AM   Subscribe

Am contemplating selling current house and buying a new one, and wondering what's the best approach: 1.) Make the minimum down payment, and use profit from home sale to supplement now larger home payments (also getting the larger mortgage interest deduction. Or 2.) Plow as much of the profit from the home sale into the new home, thus having no cushion but having a smaller mortgage. I've always thought it was best to pay as little interest as possible, but then again, one hears you should try not to tie all up your money in an asset, etc. Thoughts? Anyone seen a spreadsheet breakdown on this? Or maybe there's an easy answer staring me right in the face.
posted by dearleader to Work & Money (12 answers total) 1 user marked this as a favorite
If you can put enough down to get a 15 or 20 year mortgage instead of a 30, your interest rate will be lower. Tax deductions are nice; but paying less interest is always a better deal, and getting the house paid off sooner is really terrific.
posted by theora55 at 11:41 AM on March 19, 2011

The unknown factor here is your income, and how secure that is. The last thing you want is to put yourself in a situation where your house payments go up and your income goes down.

You could also do 3) reserve a small cushion (say, 6 months of living expenses) from the proceeds of the sale and then plow the rest into the down payment.

Tax deductions are nice; but paying less interest is always a better deal This is excellent advice.
posted by ambrosia at 11:58 AM on March 19, 2011

I had this same problem about 2 years ago. The advice I got has worked for me - make the normal 20% downpayment, put the rest away as a cushion/saving account for the inevitable changes you'll want or need to make to the new house. Having that kind of money in savings is a new experience for me and it's astounding what it's done for my peace of mind. I will note that I didn't have enough excess to make a shorter mortgage possible; that might have changed my outlook.
posted by donnagirl at 12:27 PM on March 19, 2011 [1 favorite]

If you can find an offset mortgage, or a mortgage where you can overpay and then easily borrow back against the overpayments, that could be a good option - so long as your overpayments reduce the term of the mortgage, reducing the total financial liability.

Take out the mortgage, dump most of the excess straight into the offset account or as an overpayment, and you'll be paying less interest while still being able to rely on the extra if you hit hard times, have a kid, or want to do up the kitchen.
posted by emilyw at 12:33 PM on March 19, 2011

I remember doing the calculations on a website and came to the conclusion that having a 30 year mortgage, but making the monthly payments equivalent to a fifteen year mortgage had it paid off in ~18 years (IIRC).

Not quite the answer to your question, but that struck me as a really good way (if you have the discipline) to pay off a mortgage quickly, while still having a much smaller monthly financial obligation if you run into unexpected financial problems.

(Whereas if you have the 15 year payment structure and don't have a lot of leeway in your total income, a rough patch could mean missed mortgage payments.)
posted by BleachBypass at 1:23 PM on March 19, 2011

offset mortgages don't exist in the US, OP's history would seem to imply he's american.

If your job is secure, really it is entirely up to. Assuming you can put 20% in either scenario you really won't save much on the mortgage rate (assuming both scenarios also qualify as conforming) and mortgage rates are very low right now. The rest is a function of your risk tolerance. Basically the cost of more leverage is mortgage rate*(1-your marginal tax rate) - short term money market. ('cause I'm assuming you'll keep it in something super safe)

Given you will lock in a very low cost mortgage relative to history there might be points in which you actually have a negative spread. Taking out more leverage is basically betting on inflation increasing in the US - keep that in mind if it appeals. I personally think have some free cash is risk diversifying, so I think putting less down on a house (i.e. 20% instead of 35%) is rational - if you know you won't spend the excess.

So basically figure out what it is going to cost you per year to be more levered and look at that like it is an insurance premium - then ask yourself if you are happy to pay that.

I would caveat this by saying - this only applies if you are really going to keep the money in something very low risk and not spending it.
posted by JPD at 2:57 PM on March 19, 2011

Be careful about putting too much weight on the mortgage interest tax deduction. Remember that what you save in taxes is just a fraction of what you pay in mortgage interest:

-- first, you need to itemize deduction. This year that's about $5000 for a single person and $11K for a married couple (figures not exact.) Clearly if you itemize you can deduct other expenses too, but if those other expenses are small relative to those limits, and the mortgage interest is really the only expense that's a significant fraction of those amounts, then take that into consideration. I.e., the first $5k or 11K of your mortgage interest is must money out of your pocket, no tax benefit whatsoever.

--Then, it's only the amount of mortgage interest you pay *above and beyond* the standard deduction that gets knocked off your taxable income.

--Then, only a fraction of that "above and beyond" amount gets taken off your tax bill, depending on your marginal tax bracket.

Example: you're married, you pay $14K in mortgage interest in a year, your marginal tax bracket is 30%, you have no other significant deductions. In this case, only $3K ($14K - the $11K standard deduction) gets knocked off your taxable income, which reduces your tax bill by about $1K (30% of 3K). You save $1000 on your taxes--but only after $14K have come out of your pocket and are gone forever.

You know your numbers better than we do--do the math yourself, see what makes sense for you.
posted by Sublimity at 2:59 PM on March 19, 2011 [3 favorites]

The more money you put into the down payment, the smaller the mortgage, and the smaller the chance your mortgage will go underwater at some point. Of course, you don't expect your mortgage to go underwater, but look at all the mortgages currently underwater. It's a tight spot you really want to avoid.
posted by exphysicist345 at 4:45 PM on March 19, 2011

The more money you put into the down payment, the smaller the mortgage, and the smaller the chance your mortgage will go underwater at some point. Of course, you don't expect your mortgage to go underwater, but look at all the mortgages currently underwater. It's a tight spot you really want to avoid.

This is correct, but only if you are viewing your house as a temporary thing, or as an investment. (Hint: a thing is not an investment if you need that thing.)

If you are instead looking at it as what it REALLY is- buying a thing that you need- then what its market price happens to be 5 years from now is irrelevant. You've got a place to live at a price that was acceptable to you.
posted by gjc at 5:30 PM on March 19, 2011

That doesn't make sense at all.
1)Being underwater makes your home harder to sell, but it doesn't make it any harder to make you payments
2)If you are underwater and you want to move and you can't execute a short sale, then you can just inject the cash you have in your reserve account.
posted by JPD at 5:31 PM on March 19, 2011

Remember that when you move into a new place you'll find unexpected repairs, you might want to buy new curtains/rugs/whatever, maybe your bookcase won't fit and you'll want another one, blah blah blah. So set aside more money than you think you'll need for that sort of thing. Inspections miss things that you will only find once you've been living in the new place for a while.
posted by LobsterMitten at 11:21 AM on March 20, 2011

Let's remind everyone that a house is NOT an asset (e.g. Kiyosaki - say what you will about the man, but an asset is something that puts money into your pocket).

I would start with a fair share of that money going into your emergency fund - whatever sounds safe, then add a bit more - then plowing everything else into your down payment. You'll be getting a tax deduction, sure - but remember that the deduction means you're saving twenty-odd cents after spending a dollar.
posted by chrisinseoul at 11:25 AM on March 20, 2011

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