Which homebuying strategy to take re retirement vs loan duration?

September 12, 2021 6:27 PM

A month ago I was living in a little rental with no immediate plans to change that, and contributing 15% of my income to retirement and feeling really blessed to be able to do that. But I'm suddenly planning to buy my neighbor's house, and now I'm trying to understand the best strategy forward.

About me:
I'm 53 in Washington State, in a stable full-time remote job for coming on two years that I don't expect to change anytime soon. I'm not so fortunate that I imagine I can retire much before age 70, but who knows. I should be able to avoid PMI. I am single without children. I have no debt. I am healthy for now.

Whatever I do, in order to pay the mortgage, I'll need to reduce the percent I put into retirement to some degree. Do I go for a 20- or 30-year mortgage? And... points, huh? My choices (if I pay about $3,000 for points):
a) the 20-year with a .33% lower rate and about a $500 higher monthly payment.
b) the 30-year and the more comfortable cash position.

Also...points?
From what I understand, if I'm planning to stay in the house for a long time (I am), it's worth buying points. Next to the rates for the 20- and 30-year loans are numbers for points ranging from roughly $3,000 to $9000. I picked the rates for the ones closer to $3,000, but I could lower the 20-year by .042 if I pay $9400, and the 30-year by .056 or .129 if I pay $6100 or $8900, respectively. And finally is it better to make a bigger downpayment or use that $$ for points?

So reduce my retirement contribution more or less? Shoot for 20- or 30-year loan? Does it make sense to do the 20 year if it means I must really reduce my retirement contribution? And how should I be looking at points?

Thanks for sharing your knowledge and experience. :)

posted by AnOrigamiLife to Work & Money (14 answers total)

You should make a spreadsheet! There are a bunch of inputs: points, loan term, interest rate, tax rate, and expected retirement account returns. Your output should be, how much money do you have at age 70, net of your remaining loan principal?

Points vs down payment in particular is a simple modeling exercise, where you figure out how much money you'll be paying over some time horizon in each scenario. The only thing to remember is that refinancing exists, so even if you're staying in your house for 20 years, you're only benefitting from the lower interest rate if interest rates stay the same or go up. Now interest rates are so low these days that that's a pretty fair bet, but still.

Most of the tricky bits about this are related to tax.

Remember that your retirement account contributions are tax-deferred, and also that you may be able to claim the mortgage interest tax deduction, but only if you itemize. Here in New York, the tax deferral from retirement savings is worth more than in Washington where you don't have state income tax anyway.

The lower your marginal tax rate is, the more sense it makes to pay a lower interest rate and contribute less to your retirement account. Every dollar you pay in interest is a dollar you don't get back, while the dollars you contribute to principal are adding to your net worth, even if you don't get to invest them directly. But to the extent that the government is paying you to save, you should probably do it, even if that means giving a little more to the bank.

(If you have an employer with 401(k) matching, make sure to model that too!)
posted by goingonit at 7:08 PM on September 12, 2021 [2 favorites]

I wouldn’t pay points. Don’t just think about how long you’ll stay in the house, think about how long you’ll keep the mortgage - I’ve refinanced every year since buying my first house in 2018 (just locked in my rate for my third refinance on Friday), because rates keep going down. My mortgage payment now is like 15% less than it was when we bought the house. Can interest rates actually get much lower than they are right now? I would think not, except that’s what I thought last year.

I would prioritize keeping your payment low and maximizing your retirement contribution, so long as you’re investing those retirement savings in something that is likely to yield more than your mortgage interest rate. Interest rates are so so low right now, you will come out ahead so long as your retirement investments yield more than ~3%. If interest rates go up, awesome, you locked in this low rate for as long as you care to own the house! If interest rates get even lower, you can refinance!
posted by mskyle at 7:13 PM on September 12, 2021 [4 favorites]

Get rates from a credit union; even small differences in rates add up fast. Rates are so low, what a great thing to have this opportunity. Yes, put it all in a spreadsheet. You're 53, and a 20 or 25 year mortgage feels a lot more reasonable, but with such low interest, it makes sense to get a long mortgage and keep at least a portion of your 401K in something secure that you could tap if it became necessary.
posted by theora55 at 7:30 PM on September 12, 2021 [3 favorites]

Can you / will you want to move someplace cheaper when you retire? In general I would be even more comfortable leaning toward sinking less of your saving into downpayment and points if you could / would be willing to move somewhere cheaper in retirement.
posted by ldthomps at 7:37 PM on September 12, 2021

I've found the calculators here helpful in modeling this sort of thing: link There's one for deciding about points, for example. Whether it's worth it depends on how long you'll be in the house, but also on what you assume your rate of return is on that money if you don't use it to buy points but invest it instead.
posted by matildatakesovertheworld at 9:06 PM on September 12, 2021

Response by poster: Wow, thanks everyone. For anyone still interested in weighing in, some more details... but first, @goingonit I'm really not clear on how to do the spreadsheet. I mean, yeah I know the basics of Excel, but things like how much money do you have at age 70, net of your remaining loan principal? and marginal tax rate I just don't know what to do with. I'd have zero confidence that I'd done it or interpreted it correctly. Is this something I might pay a flat rate for some kind of professional to whip up for me? Are lenders supposed to help with these decisions or are they too self serving to trust?

Also: I don't itemize. And retirement returns...that's a post for another day, but many jobs over many moves over many years and I have a half dozen retirement accounts with different companies, and I've always been afeared of the dreaded "locking in losses" to roll them into one another. Never been savvy about how to invest it, though I've gone through brief stints of reading Morningstar and throwing darts, adjusting for recommended asset allocation and then not touching anything again. Kind of a dolt in this area, and somewhat recently widowed and neither of us ever focused on learning this stuff as we should have. I just didn't anticipate doing this without another head in the mix. I'm generally a smart and educated woman, but this stuff (e.g., fear around finances, making wrong choices) paralyzes me almost as much as grief has.

As much as I like the idea of a 20 yr, you all make some good points and the smartest choice to enable me to still contribute to retirement and have cash on hand is a 30 yr. @theora55, it's not a CU, but I'm preapproved with a big online company that came recommended (and has lower rates than my CU) and their published 30 yr options right now are, at the lowest, 2.375% (2.560APR) with points at close to $9k, or two other cheaper points options. And then the closest thing listed to 0 points for the 30 yr shows a credit (not sure what exactly that means, though it appears to be the opposite of points) of $883, for 2.750% (2.770APR).

When I think of the points thing and just how friggin much I'm putting down, $9k is a lot, but if $9k now to get .375 lower (other points options are 6.1k for .25 lower, or 2.4k for .125 lower) translates to something significant over a few years, maybe it could make sense? This is also where I don't know if it's just better to pay more down if I have that available. And I do get your points about how I might invest that amount instead, but clearly I know nothing about savvy investing. I just don't know how it all pencils out.

@ldthomps I am in a crazy-expensive market, and that's because it's among top places to retire. A happy accident that we landed here. I could but wouldn't want to move. This place feels like home and this is where my community is and I've never understood those who choose to uproot their lives and move as strangers to another town after retirement when it's so much harder to build community as we age. I've moved a hella lot and I want to nest in familiarity in this last place where my person shared my life. Time changes us. Not on my radar at all, but who knows, and it was a great thing to bring up.
posted by AnOrigamiLife at 10:18 PM on September 12, 2021

here's my thought to make it simple:
You are going to retire in about 10 years so neither a 20 year nor 30 year mortgage would be paid off. I would opt for the thirty year since that give you the lowest monthly payment. If you want to pay it off faster you can always make additional payments each month to pay it off faster. Rate will be a little higher than a 20 year but rates in general are so low that it won't add too much to the monthly payment.

Second, most mortages don't last that long - if you don't sell, you might refinance. if you are trying to get a sense of tradeoffs between points and extra monthly payments I would look for something that pays off in less than five years. If you factor in the time value of money, savings in the future rapidly drop in value the further in the future you go so it's not a terrible rule of thumb.
posted by metahawk at 12:14 AM on September 13, 2021 [3 favorites]

This may or may not be relevant for your location as none of the other MeFites mention it but in some jurisdictions, a 30 year mortgage would not be available to somebody your age. The rationale is that people require a high enough income to make the mortgage payments and that most people have to accept a drop in income on retirement. They then may no longer be able to make the payments after retiring.

If that's not something lenders in WA worry about that's great. But if it is relevant, it will affect your calculations. There are typically ways to deal with such restrictions but the work arounds would also complicate the calculations or require additional collateral.
posted by koahiatamadl at 2:26 AM on September 13, 2021

What is the purchase price of the home, what are the rates being offered, what is your tax bracket, how much in savings do you have (all sources) and what are your retirement saving options and contributions at the moment? This is a relatively basic modeling exercise but those are critical inputs. Rules of thumb are often wrong...but I would say that there is likely little reason to put more down than necessary to get the best rate given how low rates are.

And points are always a function of cost versus expected savings over expected time living in the home. No one can say whether they are a good idea without knowing those.
posted by redondo77 at 4:05 AM on September 13, 2021

If you like, DM me, we can walk through it together. I have one from when my wife and I were making these decisions that I can just take the numbers out of and share
posted by goingonit at 5:12 AM on September 13, 2021

Here's a calculator that lets you put in the details of your loan-with-points and your loan-with-no-points - you can see how long it will take a loan with points to pay off compared to a loan without points by adjusting the "years in home" slider (which really ought to be "years with this mortgage" to take account for potentially refinancing while you still live in the home).

Anyway, like I said I very strongly advocate for minimizing your closing costs and your monthly payment when interest rates are this low - I know a lot of mefites (and other people on the internet) disagree with me but I'd rather have a big mortgage at <3% and a lot of money in investments/cash in the bank than no mortgage and no cash in the bank.
posted by mskyle at 5:32 AM on September 13, 2021 [2 favorites]

Don't buy points.

Reference: I bought a house/mortgage 1.5 years ago. Interest rates were "historically low" then. I expected to stay in the house a long time, so I paid $10k in points. Expected 'break-even' for those points was about 4 years.

1.5 years later, I'm re-financing, because interest rates are EVEN LOWER than they were 1.5 years ago. And I'm eating the points I bought 1.5 years ago.
posted by u2604ab at 7:35 AM on September 13, 2021 [1 favorite]

IMO, you should do whatever gives you the lowest possible payment for the same term (ie: compare 30 year to other 30 year options). You have to calculate with and without points, since mortgages are made to be confusing.

Lowest monthly payment is the goal with a mortgage. The rest, things like 'ease of working with', 'friendly customer service' etc are nonsense.

I prefer 30 year mortgages, since you say you are already behind on your retirement savings and you have no huge outlays for children (like college) in your future.
posted by The_Vegetables at 12:00 PM on September 13, 2021

Sorry for the late reply, but I've just read this.

Also: I don't itemize.
With all of the tax changes lately, most people don't itemize anymore. In my experience of doing roughly 100 tax returns per year, single homeowners are the most common scenario for itemizing being a better deal, especially early in the mortgage when they are paying more deductible mortgage interest. I know WA does not have income tax, but you'll be paying property taxes that are also deductible.

If you just started a mortgage in the last quarter of 2021, this probably won't apply for your next return. But you are paying 12 months of property tax and mortgage interest for 2022 and if that gets you anywhere close to $12,550, you should evaluate this on your return for 2022, which you will file in early 2023.
posted by soelo at 7:14 AM on December 31, 2021