It’s been said that we write to learn what we think. Putting thoughts to paper allows you to both identify and clarify the whys behind certain decisions. Such is my purpose today.
I’ve lived in my current home for eleven years. I bought it when I was 24 just after getting married. It had plenty of room to start a family, but after a bull market in babies, we’re bursting at the seams. The lack of a yard with three rambunctious boys is particularly troublesome. So we finally decided to build a bigger house on a larger lot.
One of the decisions facing me is how much money I want to put down on the new place. And this is where my analytical mind takes over. I have two choices:
One: put a large chunk down to keep the monthly payments small.
Two: put a small chunk down to keep the bulk of my capital liquid and accessible but deal with larger monthly payments.
The home buyers dilemma
Rates, How Low Can They Go?
Let’s think about the variables that enter the equation:
First, what are interest rates? The lower the borrowing cost, the greater the incentive to place a small down payment and finance the rest. With the recent beat-down in interest rates, 30-year mortgage rates have dropped to 3.75%. That’s cheap and bolsters the argument for a small down payment such as 20% to dodge PMI.
Remember, mortgages are the cheapest money you can get making a case for big home loans easier than a credit card or auto loan.
At first, I ran numbers comparing financing different amounts, but then I got smart and simplified. With rates at 3.75%, what is the monthly payment for borrowing $100k?
Answer: $464 (this is Principal & Interest only). Homeowners Insurance and Property Tax will obviously add to it. But we’ll lay that aside for today’s article.
For every $100k extra to borrow, I would add about $464 to the monthly cost.
$200k = $926
$300k = $1,389
$400k = $1,852
$500k = $2,315
etc…
And that brings me to this simple and straightforward question:
Would you rather have $100k more in the bank and pay $464 more on your monthly mortgage payment OR have $100k less but save $464 on your monthly mortgage payment?
Some seek as small
YA, BUT…
Do you know how long it would take to save up $100k at a rate of $464 per month? 216 months, or 18 years!
So let me get this straight. You’re saying bye-bye to $100k today, so you can save $464 per month and potentially in 18 years have the $100k back?
Thanks, but no thanks.
Putting a lot down to score a much lower payment seems safer, but it’s a mirage. To illustrate just look at an extreme example.
Nancy has $100k in the bank. She throws it all into a down payment on a $300k house.
Nancy
Pre-House Purchase: $100k cash, $0 mortgage
Post-House purchase: $0 cash, $200k mortgage
Monthly Payment: $926
Sam has $100k in the bank. He throws nothing into a downpayment and finances the whole $300k. I’m pretending he doesn’t have to pay PMI insurance. Again, trying to keep things simple here.
Sam
Pre-House Purchase: $100k cash, $0 mortgage
Post-House Purchase: $100k cash, $300k mortgage
Monthly Payment $1,389.
Fast forward three years. Nancy squirreled away the $464 each month to rebuild her nest egg. Sam, meanwhile, saw $464 extra in payments eat away at his bank value. Both earned 0% interest along the way because, well, they’re idiots. Also, I’m ignoring that they paid down the mortgage a bit.
Let’s take a new look, three years in:
Nancy
Post-House purchase: $16,704 cash, $200k mortgage
Sam
Post-House purchase: $83,296 cash, $300k mortgage
In year three, the unthinkable happens, and they both lose their jobs. With $16,704 in cash, Nancy can afford her mortgage payment for another 18 months. Then she’s living under a bridge with the other co-workers that took the “safe” route of high
Who would you rather be?
And what if I didn’t handicap them both and assumed that they made a few percentage points in return on their money? Sam’s situation starts to look even better. Like way, way better. He has $100k to invest right off the bat. Nancy has zero, zip, nada.
Sam, Sam, he’s our man!
Am I missing anything? If so, do tell.
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3 Replies to “Tales of a Technician: A Real Estate Would You Rather”
Tyler,
Great article.
Even though, I rather prefer Sam’s approach . I just want to point that, in any situation Nancy has more equity on the property than Sam. So, if they were forced to sell, she would feel like a winner. (a different way to see it)
Tyler
Good Thinking ! Now to state the obvious.
The larger bank account would allow you to invest and even a 2% return would make the payment plus add to savings. Then as the account/income grows extra on the payments, would then pay off early saving thousands on interest. While also increasing the nest egg, two birds one stone.
Good Luck You got it !
Tom Flohr
Based on this logic, anyone who has property free and clear should mortgage them and put the money in the market.
OK
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