Home Buying 201 -- Mortgage plus a start-up windfall?
January 24, 2016 10:06 PM Subscribe
How much house can we afford and what's the smartest way to buy given our parameters: healthy savings for a down payment, both spouses working but soon only one, and possible big pay-out in the next 12 months?
My spouse and I are looking at buying a house in a major East Coast metro area in Summer/Fall 2016. We are moving to town this summer, so will need somewhere to live right away. We've got about $425k to our name saved up between bank accounts, Vanguard investments, and retirement funds. Our current salaries are ~$90k a year and ~$55k; the lower earner, however, is planning to stay home with our child starting this summer. That means we'll have about $7.5k/month coming in pre-tax. No debt of any kind. Real estate that could more-or-less work for our family spans the range from $400k to $1 million+.
Here's the twist: The spouse who is staying home is stepping down from their role as the CEO of a mid-sized VC-funded company. They are 75 percent sure there will be a new round of financing in the second half of 2016 which would allow them to pull out cash that would equal most or all the the cost of a home.
How much house can we afford? And how do we play this? Rent and wait until the money materializes (or not) before buying? Buy what we can afford now and pay off the mortgage with the windfall? Other options we're not thinking off?
First time buying a home and first-time cashing out from a start-up, so we're trying to figure out how to sequence this and avoid costly mistakes while still getting a great place to live.
My spouse and I are looking at buying a house in a major East Coast metro area in Summer/Fall 2016. We are moving to town this summer, so will need somewhere to live right away. We've got about $425k to our name saved up between bank accounts, Vanguard investments, and retirement funds. Our current salaries are ~$90k a year and ~$55k; the lower earner, however, is planning to stay home with our child starting this summer. That means we'll have about $7.5k/month coming in pre-tax. No debt of any kind. Real estate that could more-or-less work for our family spans the range from $400k to $1 million+.
Here's the twist: The spouse who is staying home is stepping down from their role as the CEO of a mid-sized VC-funded company. They are 75 percent sure there will be a new round of financing in the second half of 2016 which would allow them to pull out cash that would equal most or all the the cost of a home.
How much house can we afford? And how do we play this? Rent and wait until the money materializes (or not) before buying? Buy what we can afford now and pay off the mortgage with the windfall? Other options we're not thinking off?
First time buying a home and first-time cashing out from a start-up, so we're trying to figure out how to sequence this and avoid costly mistakes while still getting a great place to live.
We will probably need more information. Some major East Coast metro rental markets are far tighter than others (think New York or Boston, which feature renters competing to live in unfinished and unlicensed apartments, versus Washington, where it's more of a renter's market).
posted by infinitewindow at 10:36 PM on January 24, 2016
posted by infinitewindow at 10:36 PM on January 24, 2016
If I had $425k and wanted to buy a house in the $400k to a million dollars range, I would buy the $400k house.
If you get more money next year, you get more money next year. You can donate it or retire on it or something.
posted by aniola at 11:09 PM on January 24, 2016 [1 favorite]
If you get more money next year, you get more money next year. You can donate it or retire on it or something.
posted by aniola at 11:09 PM on January 24, 2016 [1 favorite]
It's virtually impossible to answer this question without location information. You may have a million bucks but you only have one income of $90,000 a year. The property tax on an assessed $1M home in Boston's Back Bay is $8,500. In New York it would be $20,000. This is a very significant difference.
posted by DarlingBri at 11:14 PM on January 24, 2016 [3 favorites]
posted by DarlingBri at 11:14 PM on January 24, 2016 [3 favorites]
You shouldn't be planning to spend all your retirement savings on a house. How old are you guys? When you say 'retirement savings' do you mean the money is in protected accounts like a 401k?
posted by the agents of KAOS at 11:48 PM on January 24, 2016 [1 favorite]
posted by the agents of KAOS at 11:48 PM on January 24, 2016 [1 favorite]
Mod note: From the OP:
Some more facts! We're looking to buy in or around Washington, D.C. The spouse who will still be working is a federal employee. We're in our early 30s. About $150k of our savings is in a 401k (Thrift Savings Plan). Our general thought was to have our down payment of about $250k or less--though that's more a number we've pulled out of thin air. I've heard you can borrow up to $50k of your TSP for a home loan, but have had many people recommend against that if not necessary. Thanks so much for the responses already!posted by taz (staff) at 2:10 AM on January 25, 2016
Buy based on the money you have in hand, not the money that you're '75%' sure you might have a year from now.
Or rent for a year, which will give you time to see for certain how your finances settle, plus you'll have a chance to get a closer look at what you do and don't like about prospective neighborhoods.
posted by easily confused at 2:51 AM on January 25, 2016 [8 favorites]
Or rent for a year, which will give you time to see for certain how your finances settle, plus you'll have a chance to get a closer look at what you do and don't like about prospective neighborhoods.
posted by easily confused at 2:51 AM on January 25, 2016 [8 favorites]
If I were you, I'd designate a certain amount of your savings to be used for house money (say, $150K). Let's say you buy a $600K house, if you do a 20% down payment that would be $120K. Invest the remaining $30K plus whatever windfall you get and that can be your mortgage fund. You should be able to pay your mortgage through your earnings and interest on your mortgage fund. I wouldn't pay off the house entirely, because mortgage interest tax deductions are pretty substantial and with your reduced income, you may have unexpected expenses that you'll need to cover.
posted by chickenmagazine at 3:55 AM on January 25, 2016 [1 favorite]
posted by chickenmagazine at 3:55 AM on January 25, 2016 [1 favorite]
NEVER make financial decisions (especially big financial decisions) based on money you don't already have. Don't buy things because you expect to get a bonus. Don't spend more because you think you're going to get a raise. Don't make purchases because you think a windfall is coming your way. NEVER spend money you don't actually have.
I've been writing about money for a decade now, and I've heard many many horror stories from folks who have made financial decisions because they just knew they were going to get a raise or a bonus or an inheritance, and then that money never showed up. They knew it...but it didn't happen.
Okay, that part of my answer out of the way, let's get on to how much house you can afford.
I think a better place to start is "how much house do you need?" What are your family's goals? What is the purpose of this house? How long will you live there? How much space do you have now? Does it seem like too much? Too little? Do you want your home to be in a walkable neighborhood? In a good school district? I think it's more important to answer these questions before setting a budget. Based on your personal (and family) goals, you can decide what sort of home is best for you. Or whether you should even buy at all. (Renting is a perfectly acceptable option.)
Next, you can set a budget. Banks will tell you that your housing payment (principal, interest, taxes, and insurance) can be up to 33% of your gross. And truthfully, that's the guideline most Americans follow. But most Americans are stretched tight with their money. You'll put yourself in a much better position if you keep your housing costs low. (In fact, the single best move you can make with your money is to keep your housing costs low. Nothing else makes such an impact on your budget. A low housing payment gives you incredible flexibility with your future. A high housing payment restricts your options.)
For our purposes, your budget should be based on one number only: the $7500/month income of the highest earner in the household. Nothing else matters really. A bank or mortgage broker would tell you that you can therefor afford a housing payment of about $2500 per month. I'd encourage you to keep it below $1875 (again, that's for principal, interest, taxes, and insurance).
Bottom line: Assuming you can come up with $100,000 for a down payment, you can probably afford a home priced between $400,000 and $500,000. If you aim for more than that -- as everyone involved in the process will encourage you to do (including your own real estate agent) -- you put yourself in a much more difficult financial position in the long term. I'm not saying that you'll struggle. But you won't be getting ahead, and you won't be giving yourself a cash cushion to accomplish your other goals in life.
posted by jdroth at 4:54 AM on January 25, 2016 [13 favorites]
I've been writing about money for a decade now, and I've heard many many horror stories from folks who have made financial decisions because they just knew they were going to get a raise or a bonus or an inheritance, and then that money never showed up. They knew it...but it didn't happen.
Okay, that part of my answer out of the way, let's get on to how much house you can afford.
I think a better place to start is "how much house do you need?" What are your family's goals? What is the purpose of this house? How long will you live there? How much space do you have now? Does it seem like too much? Too little? Do you want your home to be in a walkable neighborhood? In a good school district? I think it's more important to answer these questions before setting a budget. Based on your personal (and family) goals, you can decide what sort of home is best for you. Or whether you should even buy at all. (Renting is a perfectly acceptable option.)
Next, you can set a budget. Banks will tell you that your housing payment (principal, interest, taxes, and insurance) can be up to 33% of your gross. And truthfully, that's the guideline most Americans follow. But most Americans are stretched tight with their money. You'll put yourself in a much better position if you keep your housing costs low. (In fact, the single best move you can make with your money is to keep your housing costs low. Nothing else makes such an impact on your budget. A low housing payment gives you incredible flexibility with your future. A high housing payment restricts your options.)
For our purposes, your budget should be based on one number only: the $7500/month income of the highest earner in the household. Nothing else matters really. A bank or mortgage broker would tell you that you can therefor afford a housing payment of about $2500 per month. I'd encourage you to keep it below $1875 (again, that's for principal, interest, taxes, and insurance).
Bottom line: Assuming you can come up with $100,000 for a down payment, you can probably afford a home priced between $400,000 and $500,000. If you aim for more than that -- as everyone involved in the process will encourage you to do (including your own real estate agent) -- you put yourself in a much more difficult financial position in the long term. I'm not saying that you'll struggle. But you won't be getting ahead, and you won't be giving yourself a cash cushion to accomplish your other goals in life.
posted by jdroth at 4:54 AM on January 25, 2016 [13 favorites]
Now, having said all of that, if you really do think there's a good chance you're going to get a windfall, then by all means wait to see if it happens. Don't buy yet. Rent. If/when you get the windfall, then factor that into your decision. If you were to get, say, $500,000 all at once, then buy a $500,000 home. That would be a dream situation!
posted by jdroth at 4:58 AM on January 25, 2016 [7 favorites]
posted by jdroth at 4:58 AM on January 25, 2016 [7 favorites]
Wait. Rent. Explore the market. Do you want to live in DC, VA or MD? Renting gives you time to truly understand your options. You don't buy the biggest investment of your life in a hot hurry.
Once you have cash in hand, you'll be in a better position to decide how much of it you want to invest in a home.
The usual computation is you can afford a mortgage payment that's 25% of your income. So at $90,000, it would be $1875 monthly. That $1875 will include tax, escrows, etc.
Also, don't borrow against your 401(k) to buy a house. Not if you don't have to.
posted by Ruthless Bunny at 5:10 AM on January 25, 2016
Once you have cash in hand, you'll be in a better position to decide how much of it you want to invest in a home.
The usual computation is you can afford a mortgage payment that's 25% of your income. So at $90,000, it would be $1875 monthly. That $1875 will include tax, escrows, etc.
Also, don't borrow against your 401(k) to buy a house. Not if you don't have to.
posted by Ruthless Bunny at 5:10 AM on January 25, 2016
You basically absolutely need to wait to see if that payout comes.
The fact you would be substantially a cash buyer (because of the disparity between savings and future compensation) means you really should wait for interest rates to go higher unless you have some belief rates are never going up. Also I guess it matters how old the kid is WRT the importance of them having stability for school.
posted by JPD at 5:43 AM on January 25, 2016 [2 favorites]
The fact you would be substantially a cash buyer (because of the disparity between savings and future compensation) means you really should wait for interest rates to go higher unless you have some belief rates are never going up. Also I guess it matters how old the kid is WRT the importance of them having stability for school.
posted by JPD at 5:43 AM on January 25, 2016 [2 favorites]
Rent and wait until the money materializes (or not) before buying? Buy what we can afford now and pay off the mortgage with the windfall?
As others have said, don't buy based on a potential windfall. Either buy based on your current higher single income and celebrate paying off the mortgage if the windfall does come, or rent and wait to see what your actual situation is at that time.
I've owned a couple of houses now, and although it has worked out for us, owning is making me a bigger proponent of renting, at least from a financial perspective. (Owning is way better in terms of not dealing with terrible landlords, obviously.) I'd think about how long this stay in DC is really likely to be, and how much exposure you are comfortable with in case there are any dips in house prices a few years from now, for example, as part of this decision.
posted by Dip Flash at 5:54 AM on January 25, 2016
As others have said, don't buy based on a potential windfall. Either buy based on your current higher single income and celebrate paying off the mortgage if the windfall does come, or rent and wait to see what your actual situation is at that time.
I've owned a couple of houses now, and although it has worked out for us, owning is making me a bigger proponent of renting, at least from a financial perspective. (Owning is way better in terms of not dealing with terrible landlords, obviously.) I'd think about how long this stay in DC is really likely to be, and how much exposure you are comfortable with in case there are any dips in house prices a few years from now, for example, as part of this decision.
posted by Dip Flash at 5:54 AM on January 25, 2016
Since no one else has mentioned it, the one thing I don't see mentioned in your list of options is to buy a house on the low end of your range with a "normal" down payment (20% or whatever you need to avoid PMI), and leave the remainder of the money in reasonable investment vehicles that will return a higher % than the interest rate on your fixed rate mortgage. Since mortgage rates are still super low, the only reason to go paying off your house early is if you expect you wouldn't be able to do as well putting that money in index funds and then paying your monthly mortgage bit by bit. You can say there's a psychological value to paying it all off, and if having more untouchable funds makes a difference in how you manage your money (which it can for many people) it may even be the better move. But don't think just because you're expecting a windfall that the best use of it is automatically to pay off debt. You really want to consult a fee based financial advisor or accountant and/or do some good scenario modeling on your own where you look at the tax implications of the changing incomes, the potential windfall, and the mortgage deduction, to name a few.
posted by deludingmyself at 7:12 AM on January 25, 2016
posted by deludingmyself at 7:12 AM on January 25, 2016
I just wanted to chime in on the "don't spend it til you've got it" message. My spouse is the co-founder of a startup that is doing well and has a strong path to an IPO. This is not a "unicorn" situation, but there's a really good chance that in 2-3 years he could see a multimillion $ return. Until that happens, we are absolutely living Plan B, which includes me working, a mortgage we can afford, retirement savings, college savings, and everything else. If it happens I'll be thrilled, but if not we are stable and have a secure plan.
I've been around the block on this startup for 5 years now, and I cannot tell you how many promising things have emerged and then not worked out, how every funding cycle takes about 2x as long as you thought, and how much it is all written in water. "A 75% chance by the end of the year" - I'm sorry, that is not what you should go planning with, especially if someone wants to stop working to stay home. Also, again speaking from specific personal experience, the possibility to cash out might not work out even if the round goes through, and if the CEO spouse steps down prior to the round closing (sounds like your timeline is this summer?) as an ex-employee they are last in line to sell that stock. Current employees/execs are going to get prioritized IF that option is there.
And will the CEO spouse need to exercise options prior to stepping down? If so, how are you covering those costs plus taxes?
Rent now, see what happens. If it does happens you're in a great position and have cash to leverage for a competitive offer. If not, you're not screwed.
posted by handful of rain at 8:50 AM on January 25, 2016 [2 favorites]
I've been around the block on this startup for 5 years now, and I cannot tell you how many promising things have emerged and then not worked out, how every funding cycle takes about 2x as long as you thought, and how much it is all written in water. "A 75% chance by the end of the year" - I'm sorry, that is not what you should go planning with, especially if someone wants to stop working to stay home. Also, again speaking from specific personal experience, the possibility to cash out might not work out even if the round goes through, and if the CEO spouse steps down prior to the round closing (sounds like your timeline is this summer?) as an ex-employee they are last in line to sell that stock. Current employees/execs are going to get prioritized IF that option is there.
And will the CEO spouse need to exercise options prior to stepping down? If so, how are you covering those costs plus taxes?
Rent now, see what happens. If it does happens you're in a great position and have cash to leverage for a competitive offer. If not, you're not screwed.
posted by handful of rain at 8:50 AM on January 25, 2016 [2 favorites]
Another snippet I'll add from a different direction is that an extra round of funding will not necessarily put the CEO/Ex-CEO in a position to take money off the table. VC investors rarely like the idea of executives (past or present) taking money off the table. Unless this is effectively a buy-out, where the investor is intentionally trying to make the CEO go away and/or replace them with someone of their own choosing I would not assume that this will be a cash-out for the CEO.
This has been said above, but "rent" is the answer. Shop around town, find where you want to live, find a realtor you trust/like, learn about the schools, learn about the market, take that time to find yourselves the right house at the right price. That exercise alone will offset the rent money that you would be "wasting". Not to mention that you do not want to get in to a long-term financial arrangement (like a mortgage) based on the assumption of a windfall event.
Lastly, when the windfall does show up, engage with a financial planner about how to shelter as much of that money as possible. That might be a house or some kind of other investment. The money you may pay in taxes on that kind of windfall is not an absolute... The proper choice here may be large house downpayment, or small house down payment, or house purchase outright. But we cannot tell you that without knowing about your precise financial situation. The "right" move is to proceed cautiously, assume nothing, and consult experts. Big transactions, big windfalls, big life-events, there is NO need to hurry anything here.
posted by milqman at 8:58 AM on January 25, 2016
This has been said above, but "rent" is the answer. Shop around town, find where you want to live, find a realtor you trust/like, learn about the schools, learn about the market, take that time to find yourselves the right house at the right price. That exercise alone will offset the rent money that you would be "wasting". Not to mention that you do not want to get in to a long-term financial arrangement (like a mortgage) based on the assumption of a windfall event.
Lastly, when the windfall does show up, engage with a financial planner about how to shelter as much of that money as possible. That might be a house or some kind of other investment. The money you may pay in taxes on that kind of windfall is not an absolute... The proper choice here may be large house downpayment, or small house down payment, or house purchase outright. But we cannot tell you that without knowing about your precise financial situation. The "right" move is to proceed cautiously, assume nothing, and consult experts. Big transactions, big windfalls, big life-events, there is NO need to hurry anything here.
posted by milqman at 8:58 AM on January 25, 2016
Synthesizing above advice: don't spend money you don't yet have; don't borrow against your 401(k); and consider the tax and liquidity advantages of having a mortgage and more money in savings, compared to no mortgage and less money saved.
In short: if your mortgage is, say, 4%, that's historically close to free money. The law incentivizes homeownership through tax policy (read: mortgage interest is tax deductible, and once you have that you get into other itemized deductions that pay off more than the standard deduction will). So you can borrow money at 4% secured by your house, incur a tax benefit for being a homeowner, and still have more liquidity (the savings you didn't spend on a down payment) to use either to invest (presumably at better than 4% – there are a number of index funds with 7% or better long term performance) or to ride out difficulties.
Borrowing money when you don't have to is counterintuitive, but it's what large corporations and banks do all the time. Put down 20% so you're not paying PMI and keep the rest of your liquidity intact, using that 4% loan as a hedge against lulls in the investment market.
But yes, talk to a fee-based financial planner to run all the different scenarios for you so something that seems smart now is less likely to bite you later.
posted by fedward at 12:15 PM on January 25, 2016 [1 favorite]
In short: if your mortgage is, say, 4%, that's historically close to free money. The law incentivizes homeownership through tax policy (read: mortgage interest is tax deductible, and once you have that you get into other itemized deductions that pay off more than the standard deduction will). So you can borrow money at 4% secured by your house, incur a tax benefit for being a homeowner, and still have more liquidity (the savings you didn't spend on a down payment) to use either to invest (presumably at better than 4% – there are a number of index funds with 7% or better long term performance) or to ride out difficulties.
Borrowing money when you don't have to is counterintuitive, but it's what large corporations and banks do all the time. Put down 20% so you're not paying PMI and keep the rest of your liquidity intact, using that 4% loan as a hedge against lulls in the investment market.
But yes, talk to a fee-based financial planner to run all the different scenarios for you so something that seems smart now is less likely to bite you later.
posted by fedward at 12:15 PM on January 25, 2016 [1 favorite]
This thread is closed to new comments.
On the other hand, there are places in the US where a half million dollars means a tiny house with a two hour commute = really lousy quality of life. In that case, rent now and wait until you know for sure if the extra money is coming in.
posted by metahawk at 10:31 PM on January 24, 2016