How do I budget for a home purchase if I have a good amount of savings?
July 8, 2013 9:14 AM   Subscribe

I'm looking to buy a home. I'm not wealthy enough to just buy something nice enough straight out, and I've got a decent idea of how much I could/should pay for a monthly mortgage payment, but over the years I've accrued more savings (in fairly low-interest places) than I'd likely put for a down payment. So how do I decide how much of my savings to put into what size of down payment (and, since I know how big of a mortgage I could pay, how do I decide how much I should spend on a house?).

I've read all about figuring out what share of your income should go to a mortgage, saving up for a down payment, and not getting as big of a loan as you're authorized to. And I've got a decent idea of what size/location I'm looking for in a home (3 bedroom, 2+ bath, for what it's worth.)

A couple paths I've thought about: 1) Keep enough savings for something like a year's salary, just as a safety buffer. 2) Analyzing the interest rates my savings are getting vs the presumed investment value of the house. However, I'm a) not getting much interest in this portion of my savings [let's say 2%, but with some work I could safely get closer to 4%] and b) not particularly expecting to have homes be a good investment ever again, so that sort of ruins both sides of the equation.

So, do I put as much as I have into a down payment? Or keep more of a buffer than one year's salary? Obviously I don't need an excessively large house, and I don't want to overpay, but there's always a nicer place that would conceivably be worth the additional cost if you can afford it.
posted by davebug to Home & Garden (13 answers total) 5 users marked this as a favorite
Do you have any other debts you are paying interest on? If the interest rate on those is higher than the interest rate you'd pay on your mortgage, you might be better off putting down the minimum down payment and using the rest of your savings to pay off those higher rate debts.
posted by Jacqueline at 9:21 AM on July 8, 2013

Response by poster: @Jacqueline Good point. Nope, no other debt.
posted by davebug at 9:23 AM on July 8, 2013

What an unusual problem!

Some things to think about:

- Do you have a spouse or dependents? If so, do you have sufficient life and disability insurance? (And relatedly, you probably want a larger safety buffer if you have kids - I have been hearing 12 months later, versus about 6 months if you don't have kids).
- Do you have sufficient disability insurance anyway?
- $20,000 would be a nice cushion for the inevitable urgent household repairs. You may not need quite that much, but you should have some readily available cash for repairs
- Anything under 20% down payment will probably require Private Morgage Insurance; it would be good to avoid PMI since you can.
posted by semacd at 9:42 AM on July 8, 2013

Don't forget to consider the cost of immediate and ongoing repairs and maintenance, and the cost of all that STUFF you end up having to buy along with your house, from washing machine to bath mat.

It's worth at least thinking about getting any short to medium term major repairs done before you move in, in which case you would need to keep back some money for that.

I don't know if this is possible where you are, but offset mortgages are a good way of dealing with your dilemma; have a smaller down payment, but use the rest of your savings as an offset, and just claw them back if you need to.
posted by emilyw at 9:43 AM on July 8, 2013

This kind of thing depends so much on your specific career and family situation and your attitudes toward money. If you're in a stable position and feel confident about your ability to find another job if you need to, I would personally put as much as possible toward the house with the goal of paying it off entirely as quickly as possible. A year's worth of salary in savings is way more than enough for me. But I am not you. The main thing is to figure out what you'll be comfortable with as a cushion.
posted by something something at 9:59 AM on July 8, 2013

Best answer: Ok, here's a few parameters:
1. You should put down at least a 20% downpayment, because otherwise you will wind up paying mortage insurance.

2. You should have some additional cash for loan origination costs, moving costs, and miscellaneous new homeowner costs.

3. It used to be that the popular figure quoted for an emergency fund was 3 months' expenses (which is not the same thing as 3 months' salary). I think 6 months is now becoming a more common figure. Regardless, 12 months' salary in low-interest liquid accounts is probably overkill. Even though year(s)-long unemployment is becoming a part of the landscape, in such situations there is a lot that can be done to tighten belts in a situation and leave you with enough money to survive even an emergency that exceeds your planned-for emergency scenario.

3. Beyond that, it is generally better to prioritize tax-sheltered savings (retirement, educational savings for the sprogs) over putting money toward downpayment/paying down a mortgage. If you've reached the 20% savings target but are not maximizing those opportunities (401(k), IRA, educational savings account) then you should be putting less cash into house savings and more toward those.

Everybody's got their own personal tolerance for these things, but there are better places you can put the cash leftover after fulfilling (1), (2), and (3) above, where it will be working harder for you but you can still tap into it in the event that you completely deplete a 6-month emergency fund. Those two basic choices would be (assuming you've maxed out your tax-sheltered investing):

(a) more toward downpayment/paying down mortgage
(b) investing in non-tax-sheltered accounts.

Either of these options is slightly more risky than leaving your money in a money market account or CDs or whatever, but you can get at a part of it in the event of an emergency of unforeseen proportions either through some form of home equity loan or by liquidating investments. I personally think putting money into the stock market is better than putting extra cash toward increasing your home equity, but if you've got enough savings/income that you can pay 20% down on a house you like, max out your tax-sheltered vehicles, keep a reasonable emergency fund in highly liquid accounts, and still have money floating around that you need to figure out what to do with, you've got enough money to merit working with a financial advisor.
posted by drlith at 10:02 AM on July 8, 2013 [2 favorites]

I would put the minimum required by the lender into the down payment. Even this will not be clear cut, as you may be offered a number of choices, e.g. an FHA loan for 3.5% down, a conventional loan with PMI for 10% down, a conventional loan with no mortgage insurance for 20% down, and possibly other options. So, consider the options a bank presents you with, and decide what will work best for you; there is no universally superior option.

One reason to not put more that the minimum required into a down payment is that if at any point in the future you decide you want to pay off some of the principal, this could not be easier to do, and the flexibility of having some cash when you move into a new house outweighs the value of having a low principal at the start of a loan, in my opinion.

Finally, do not overvalue a mortgage with no PMI. PMI is tax deductible, and is a good deal under a wide variety of circumstances. As a general rule, I would prefer to pay PMI rather than to stretch my budget to get to a higher down payment.
posted by deadweightloss at 10:02 AM on July 8, 2013 [2 favorites]

Are your savings also your retirement savings? Or are they separate?

Its hard to give concrete advice since it depends on so many things, but my most generic advice would be to put down 20% so you avoid mortgage insurance, and also have a lot of savings still liquid, in case of house repairs, unemployment, etc.

We had enough savings after the sale of our condo (at the peak of the market) to pay %50 on our next place, but chose to just put 20% down and invest the rest. Once interest rates changed so savings were not givings us very good returns, we chose to pay off a chunk of the principal and refi to get a lower mortgage rate. As deadweightloss says, its incredibly easy to pay down principal if it suits you, but its not easy to get money out of your house if you put all your savings into the downpayment.
posted by Joh at 10:10 AM on July 8, 2013

Best answer: The other thing that occurs to me in re-reading your last sentence is that if 20% down and a mortgage sized to where you're quite comfortable with the monthly payments is forcing you to limit yourself to "lesser" houses than what you'd reasonably hoped for (such as pricing you out of neighborhoods you like or forcing you into a small footprint or a house that could use a lot of renovation) AND you have enough spare cash that a bigger downpayment is going to get you into a house will make you happier in the long run, then certainly that's a valid quality of life consideration. (Because if you leave quality of life out of the equation, the smartest thing to do with your money is to invest it all and live in a van down by the river.)
posted by drlith at 10:11 AM on July 8, 2013 [2 favorites]

You should put down at least a 20% downpayment, because otherwise you will wind up paying mortage insurance.

This isn't necessarialy true. You can do two mortgages to avoid a large downpayment and paying PMI. My wife and I got our primary mortgage for 75% of the value, a second for 20% of the value, and put 5% down in cash. We went this route because we had a desire to keep our cash levels high at the time of purchase. We'll pay the second mortgage off (very) early. It will cost us a bit more because of two interest payments, but helped us meet our financial goals at the time, and gives us a larger tax writeoff every year.
posted by NotMyselfRightNow at 10:38 AM on July 8, 2013

2) Analyzing the interest rates my savings are getting vs the presumed investment value of the house.

What I would compare to your savings interest rate is not the investment value of the house but the interest rate on the loan. Not having to pay X% interest on a mortgage is equivalent to earning X% interest on savings. (Mortgage interest is tax deductible but you also pay taxes on your interest if it's in a taxable account, so the interest rates are comparable). Currently mortgage rates aren't that high, but they are still higher than what you can get in short-term savings. If you're willing to take more risk, the return you could get investing that savings could be worth more than putting more toward the mortgage.

It sounds like you're pretty good at saving money, in which case you probably don't like to have a lot of debt and might be very happy putting more money into the house so that your debt load is lower. If you go that route, make sure that all your other financial goals are covered (for example you should be well covered with insurance as people discussed above, and you should be maxing out all available retirement accounts, college fund, etc.).

The other thing to realize is that you don't have to decide now: most mortgages (all good mortgages, which you should absolutely make sure you got) have no prepayment penalty, so you could start with 20% down and then pay off another big chunk in a year once you're sure that the house isn't going to snow you with unexpected expenses.

Another strategy to consider if you want to put a lot of savings into the house but are nervous about lowering your cash cushion is to set up a home equity line of credit (HELOC) as a backup emergency fund. The cost of the HELOC is low if you don't need that money, but if you do have an emergency large expense you can get money out that you then have to pay back. The interest rate is usually fairly low because the loan is secured by your house. Let me state explicitly that doing this is a really, really bad idea if you're not financially responsible because if you blow all the money on cocaine and then can't pay it back you could lose your house - this is one common way people wound up in foreclosure during the financial crisis. But we decided to get a HELOC as a supplementary emergency fund because a) we have stable jobs and so don't need a huge emergency fund, b) we wanted to invest a lot of our savings and not have a big emergency fund sitting in a savings account earning low interest, and c) we knew that we could pay off the HELOC quickly if we needed to use it.
posted by medusa at 11:17 AM on July 8, 2013

Don't forget to take into account the lower mortgage payments a larger down-payment will give you. One of our parents died and we were able to put 50% down on our house. Combined with buying less house than we were approved for, our mortgage payments are tiny compared to those of our peers. Tiny. It makes a huge difference in our month to month quality of life and gives us a lot of flexibility in terms of what we do and how we work because we're not slaves to a huge payment. It also gives us more liquidity for things like retirement savings.
posted by DarlingBri at 1:14 PM on July 8, 2013

I'm in Australia, so the same options might not be available to you, but I describe what we ended up doing in a similar situation in my comment here.

I'm happy we did it this way.

It does mean, as DarlingBri points out, that our monthly mortgage repayments are ridiculously high, because they are calculated as though our mortgage was $200,000 higher than it could have been (if we had used all our savings as a proper downpayment). But on the other hand, the savings are sitting right there in the account that the mortgage payments are deducted from, and if we both lost our jobs or something, those high payments would keep right on coming out of the savings for about five years before we would run into trouble. And because the monthly payments are calculated on that figure of $200,000 higher than our actual (mortgage minus savings) amount, we will pay off the mortgage far faster than the 25 years it is calculated to take.

If you are somewhere where you get tax breaks on mortgage payments, I guess it might even help to have a larger mortgage payment than strictly necessary anyway.
posted by lollusc at 4:51 PM on July 8, 2013

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