Go Big Or Go Little
July 26, 2007 11:40 AM Subscribe
The wife and I just 'committed' to a pre-construction, 2200 sq/ft townhouse in Raleigh. We put down 2k and it will be finished in Mar-Apr 2008. After upgrades, the place will be about 275k. We will most likely stay in this place 5-8 years. My question is about financing.
We know nothing about the intricacies of mortgages except what I am slowly learning at Mortgage Professor. We have 100k we could put towards a down payment. Do we go for the 100k down payment, or something a little more creative? We like that fact that we would have a small bi-weekly payment, which gives us peace of mind about carrying the mortgage. We have an additional 200k tied up in index funds and cash. Is this as simple as speculating about what I could get out the stock market or an alternative investment? What factors do we need to consider?
We know nothing about the intricacies of mortgages except what I am slowly learning at Mortgage Professor. We have 100k we could put towards a down payment. Do we go for the 100k down payment, or something a little more creative? We like that fact that we would have a small bi-weekly payment, which gives us peace of mind about carrying the mortgage. We have an additional 200k tied up in index funds and cash. Is this as simple as speculating about what I could get out the stock market or an alternative investment? What factors do we need to consider?
You need to consider what your credit is like - what's the best rate you can get? Do you qualify for a prime mortgage? If so, make the lenders compete - on rates and 'points' - for your business.
When it comes to the cost of paying a note, mortgage interest on a primary residence is a good deal because of the income tax break. If you are a prime customer and get a good locked-in rate on your mortgage (no ARM!), and inflation goes up just a little bit, the inflation plus the tax break mean that in "real money" terms you are being subsidized to own the house. The income tax break is the visible, government-sponsored part of that subsidy; the inflation is the invisible part.
You would far rather be paying off your mortgage with 2027 dollars than 2007 dollars, not just because of what else you could have done with that money in the meantime (opportunity cost), but because a 2027 dollar has less purchasing power than a 2007 one (inflation).
So in addition to being handed free money over time (in terms of less income tax paid and lower real value of the mortgage balance over time due to inflation) you also get to hold on to your cash and invest it as you see fit. And you get to live in the house. You can often do pretty well in this scenario.
If you can't qualify for 'prime' lending rates or intend to buy an ARM or some other kind of instrument that lets the lender put some rate risk back on you, this whole argument falls apart and you should probably pay off the whole house.
posted by ikkyu2 at 11:55 AM on July 26, 2007 [3 favorites]
When it comes to the cost of paying a note, mortgage interest on a primary residence is a good deal because of the income tax break. If you are a prime customer and get a good locked-in rate on your mortgage (no ARM!), and inflation goes up just a little bit, the inflation plus the tax break mean that in "real money" terms you are being subsidized to own the house. The income tax break is the visible, government-sponsored part of that subsidy; the inflation is the invisible part.
You would far rather be paying off your mortgage with 2027 dollars than 2007 dollars, not just because of what else you could have done with that money in the meantime (opportunity cost), but because a 2027 dollar has less purchasing power than a 2007 one (inflation).
So in addition to being handed free money over time (in terms of less income tax paid and lower real value of the mortgage balance over time due to inflation) you also get to hold on to your cash and invest it as you see fit. And you get to live in the house. You can often do pretty well in this scenario.
If you can't qualify for 'prime' lending rates or intend to buy an ARM or some other kind of instrument that lets the lender put some rate risk back on you, this whole argument falls apart and you should probably pay off the whole house.
posted by ikkyu2 at 11:55 AM on July 26, 2007 [3 favorites]
If you are a prime customer and get a good locked-in rate on your mortgage (no ARM!), and inflation goes up just a little bit, the inflation plus the tax break mean that in "real money" terms you are being subsidized to own the house.
...but you're being offered that rate because the mortgage market thinks that, over the long term, inflation will be low enough that the lender will make a real profit. Otherwise, why would the lender be locking up money in your house for up to 30 years for a point over what money markets are paying?
Also, OP, be aware that the value of the "subsidy" is highly dependent on your personal tax situation, which may have a major impact on what kind of mortgage you want to pursue.
posted by backupjesus at 12:54 PM on July 26, 2007
...but you're being offered that rate because the mortgage market thinks that, over the long term, inflation will be low enough that the lender will make a real profit. Otherwise, why would the lender be locking up money in your house for up to 30 years for a point over what money markets are paying?
Also, OP, be aware that the value of the "subsidy" is highly dependent on your personal tax situation, which may have a major impact on what kind of mortgage you want to pursue.
posted by backupjesus at 12:54 PM on July 26, 2007
Since you already know about the Mortgage Professor, have you read his articles about this topic? He has some great articles on this topic including The Pros and Cons of Making a Larger Down Payment; Investing Extra Cash in Securities vs. Larger Down Payment; How Much Should I Put Down; and best of all a Down Payment Calculator that lets you enter various assumptions to help you decide.
However, what I think you want are people's opinions about this. As you can see from the answers you have already received, people have very different opinions about debt, the risk level of stocks, etc. This is why this is such a difficult question. If you play around with that Down Payment Calculator I linked above you will see that your answer really depends on your assumptions of how much you can make in your investments, how long you will stay in the property, and more. The problem with all of these assumptions is that if you could see into the future, you would be a billionaire and wouldn't need our advice.
What you have to base a decision like this on is what you feel comfortable with. Me, I prefer having as little debt as possible. I like the comfort that comes from having no obligations to others. That means that I would prefer to have a larger down payment, even if that wasn't completely financially "rational". You have to decide whether it is better to you to have a smaller mortgage payment, or if you would rather have more money to invest. Simple as that.
Finally, although people love to tell you that Real Estate isn't as good of an investment vehicle as the stock market, I personally believe that a guaranteed return (which is what paying less interest is) is always better than a speculative return. Most mortgage interest rates are 5-7%, if you are sure you can beat that return over the next 5-8 years, then pay less down and invest that money. Personally, I think it is difficult to really beat that return once you factor in taxes and transaction costs.
posted by bove at 1:07 PM on July 26, 2007
However, what I think you want are people's opinions about this. As you can see from the answers you have already received, people have very different opinions about debt, the risk level of stocks, etc. This is why this is such a difficult question. If you play around with that Down Payment Calculator I linked above you will see that your answer really depends on your assumptions of how much you can make in your investments, how long you will stay in the property, and more. The problem with all of these assumptions is that if you could see into the future, you would be a billionaire and wouldn't need our advice.
What you have to base a decision like this on is what you feel comfortable with. Me, I prefer having as little debt as possible. I like the comfort that comes from having no obligations to others. That means that I would prefer to have a larger down payment, even if that wasn't completely financially "rational". You have to decide whether it is better to you to have a smaller mortgage payment, or if you would rather have more money to invest. Simple as that.
Finally, although people love to tell you that Real Estate isn't as good of an investment vehicle as the stock market, I personally believe that a guaranteed return (which is what paying less interest is) is always better than a speculative return. Most mortgage interest rates are 5-7%, if you are sure you can beat that return over the next 5-8 years, then pay less down and invest that money. Personally, I think it is difficult to really beat that return once you factor in taxes and transaction costs.
posted by bove at 1:07 PM on July 26, 2007
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posted by backupjesus at 11:51 AM on July 26, 2007