Bigger cash down or retirement savings?

[thekid]

I would like to pick the board's collective brains on this subject. This is similar to the whole pay down the mortgage or save for retirement debate that doesn't seem find a clear answer, but still I would appreciate your input.

My gf and I are looking to buy a house in the near future (in less than a year, maybe in a few months). We would look into the 250K$ - 300K$ price range. I will leave my gf out of the equation as she can match or go above pretty much anything I can do. So for my share, the purchase price would be 125K$ - 150K$.

As it stands now, I plan on putting a 70K$ downpayment and leaving a max 80K$ outstanding and taking out a 15 yr loan at easy monthly payments (around 650$ a month) -I would love to throw more at the mortgage and pay it off in 7-10yrs, but for now want the wiggle room. Doing this, I would keep a fully funded 6 month EF and enough cash to buy furniture and cover closing expenses. My registered retirement savings (mostly indexed funds) would remain slightly under 40K$.

I've been wondering quite a bit about whether I'm doing this right. I'm 29 yrs old and by throwing the bulk of my means at the house today would lose significant compound effect in my retirement savings accounts. I would probably opt for a 5yr - 5% fixed term. Is 5% after tax money (and on top interest is not tax deductable where I live) better than market returns over the next 5 years? I know nobody can really answer that, but I would love to have your thoughts on how you would proceed in this situation.

Thx!

[disneysteve]

Where would you be getting the 70K? You say it would affect your retirement savings. Are you borrowing from or cashing out some retirement account to get that money? If so, then I would vote a very definite NO! Retirement money is for retirement.

Besides, I don't think there is any advantage to putting down such a large downpayment. 20% is standard (or used to be) and avoids PMI. So a 30K downpayment in your case would be plenty. I wouldn't put down any more than that, especially if I was raiding my retirement plan to come up with the funds.

[thekid]

Originally Posted by disneysteve

Where would you be getting the 70K? You say it would affect your retirement savings. Are you borrowing from or cashing out some retirement account to get that money? If so, then I would vote a very definite NO! Retirement money is for retirement.

Besides, I don't think there is any advantage to putting down such a large downpayment. 20% is standard (or used to be) and avoids PMI. So a 30K downpayment in your case would be plenty. I wouldn't put down any more than that, especially if I was raiding my retirement plan to come up with the funds.

The 70K$ is saved money (currently in taxable high interest accounts). I stated that it would effect my retirement savings in the sense that if I don't put that amount towards the cashdown, I would put a large portion of it in registered retirement savings accounts (the equivalent to an IRA in my country). I currently have slightly less than 40K in such accounts. Next years contribution space to the "IRA" would be about 22K-25K.

What I was wondering is whether I would come out significantly better off long term by, say, putting 22K-25K$ of that money into an IRA equivalent account or towards getting a guaranteed 5% after tax return (the saved interest). Maybe more than anything is the fact that I am pretty debt adverse and would love to be mortgage free by 40. I don't want to be blinded by this though.

[Scanner]

I think when you get beyond the 20% downpayment, you are just talking a matter of "taste" with how much you want to put down.

We put down about 40% down on our first house but at the same time, I did not have a job, was just starting a business and needed a "no-doc" loan (which really required documents anyway so go figure). So higher equity to put into our house to satisfy our lender was needed.

If you are debt adverse and decide to put more down. . .then to balance that, I would go all out risky in your retirement portfolio - perhaps a mix of emerging market funds, global technology and commodities.

You are then balancing conservative and agressive money management that way.

You have thought this out well - budgeting for furniture and all so you should be taking more chances in your retirement portfolio IMO.

[safari]

If I were you, I'd pay down no more than 20%. There is nothing wrong with having debt; it's all about cash flow. If you put most of your savings into the downpayment, you're going to lose a significant amount of potential income over the years which would have been generated by compunding the interest. I owe over $300K on my mortage (30-year fixed), and I could pay off half of it today, but I will continue to make minimum payments because my money is better served when it's invested isntead of being stuck in my house equity.

[Fern]

Originally Posted by safari

If you put most of your savings into the downpayment, you're going to lose a significant amount of potential income over the years which would have been generated by compunding the interest. .

Well, yeah, but the flip side to this is that by putting down more into your down payment, you're saving many thousands of dollars in interest! It's quite a significant amount, and I'd suggest talking to any mortgage banker and asking him to run you the numbers on interest with 2 different scenarios.

I put down 45% on my house 10 years ago, mainly becus i have a modest income and knew i wouldn't be able to handle a larger monthly payment. I've been prepaying for years and will have the whole thing paid off by year 17, not bad with a 30-year mortgage.

[Ima saver]

I had a much smaller mortgage than most of you guys, but I paid extra and got mine paid off in 10 years. Then I was able to go mortgage free on the next 3 houses.

[Gailete]

Sounds like you have a good paying job to have been able to save so much by your age! Good for you. By putting down the large downpayment, you will save buckets of interest which at least here in the states you wouldn't have to pay tax on this 'savings'. No sure what the tax implication would be where you are at.

One thing I would definitely do, is have that mortgage set up legally so that it is clear between you and your gf who owes what and when as gf have a way of becoming ex-gf (same with bf). Would you be able to handle the whole mortgage on your own each month if she split off? This is one of those things even married couples never seem to think about. They mortgage themselves to the hilt, fill up their cc and then decide one or the other wants out, yet they are choking in debt.

[Scanner]

I gave you the reply on what you do regarding your "taste" but yes, from a strict financial numbers standpoint, it makes sense to leverage your debt as much as possible and invest as much as possible.

So. . .from a pure numbers standpoint, yes 5% interest money is very cheap money the bank is giving you. That's cheap, cheap, cheap. To give you contrast, my unsecured line of credit through my business is running me 10.25% now (I aggressively paid it down last year when I saw it creeping up). 5% is slightly higher than inflation but not by much if you go by the 4% rule.

So, if you aren't debt adverse. . .put 20% down and invest the difference.

However, in this case, I wouldn't be so aggressive investing. I would stick with stocks indexes and diversify with some other equities (REITS, small caps maybe, whatever your beleifs) and have even a smidgen of bonds in there.

I advise this because you don't want to watch your 60% of your portfolio have a paper loss the day after you deploy it into the previous recommendation of mine - emerging markets, commodities, and global tech.

It's all about understanding risk vs. reward and what you are comfortable with.

And yes, I guess I am old fashioned but I am not sure you should be buying a house when you aren't hitched. At the very least, you need buyout clauses should the two of you decide part ways. Maybe all the more reason to keep a cash reserve on hand if you need to finance a second mortgage to buy the girlfriend out or her buy you out.

[thekid]

Originally Posted by Gailete

Sounds like you have a good paying job to have been able to save so much by your age! Good for you. By putting down the large downpayment, you will save buckets of interest which at least here in the states you wouldn't have to pay tax on this 'savings'. No sure what the tax implication would be where you are at.

One thing I would definitely do, is have that mortgage set up legally so that it is clear between you and your gf who owes what and when as gf have a way of becoming ex-gf (same with bf). Would you be able to handle the whole mortgage on your own each month if she split off? This is one of those things even married couples never seem to think about. They mortgage themselves to the hilt, fill up their cc and then decide one or the other wants out, yet they are choking in debt.

Well there are a few components to my job. I make a little over 6 figures, but am seriously considering dowshifting. Should I do that, my salary would drop back to the 70s. This is a major consideration as to why I want low mortgage payments. I want to have flexibility.

As for the gf part, she can pay off her half cash. So there is no uncertainty as to who the mortgage belongs to, it belongs to me

Basically, the 70K downpayment gives me the wiggle room I want on a 15 yr loan. A lower downpayment (say 45K or 50K) would give me the wiggle room I want on a 20 yr loan.

The way I look at this is whether I perfer a 5%/year guaranteed after tax return on my 20K-25K for 5 years (the lenght of the fixed term) or to get market returns for that same 5 year period in a tax defered retirement savings account. The intangible benefit of the former is to pay off the mortgage sooner and satisfy my debt "dislike".

What I am wondering is whether I see this right (am not missing any other important consideration pro mortgage payment or pro investment) and whether I am getting a serious short end of the stick by taking the 5% guaranteed after tax return over the tax differed market return.

[TBH]

Why not do both?

You have 70K to work with (on top of your retirement accounts, E fund, and furniture/closing money). Why not set 25K aside to fully fund your retirement accounts for next year and put 45K down on the house. You're still putting down more than 10%, but you will have that much more in your retirement account.

I am so curious about what country you live in, but I understand you want to be anonymous...

[thekid]

Originally Posted by Scanner

I gave you the reply on what you do regarding your "taste" but yes, from a strict financial numbers standpoint, it makes sense to leverage your debt as much as possible and invest as much as possible.

So. . .from a pure numbers standpoint, yes 5% interest money is very cheap money the bank is giving you. That's cheap, cheap, cheap. To give you contrast, my unsecured line of credit through my business is running me 10.25% now (I aggressively paid it down last year when I saw it creeping up). 5% is slightly higher than inflation but not by much if you go by the 4% rule.

So, if you aren't debt adverse. . .put 20% down and invest the difference.

However, in this case, I wouldn't be so aggressive investing. I would stick with stocks indexes and diversify with some other equities (REITS, small caps maybe, whatever your beleifs) and have even a smidgen of bonds in there.

I advise this because you don't want to watch your 60% of your portfolio have a paper loss the day after you deploy it into the previous recommendation of mine - emerging markets, commodities, and global tech.

It's all about understanding risk vs. reward and what you are comfortable with.

And yes, I guess I am old fashioned but I am not sure you should be buying a house when you aren't hitched. At the very least, you need buyout clauses should the two of you decide part ways. Maybe all the more reason to keep a cash reserve on hand if you need to finance a second mortgage to buy the girlfriend out or her buy you out.

Thanks for this. I haven't been investing for too long (about 4 years) and have gained returns averaging 10%-11% over that period. This has been a bull market and I guess I just don't know how much I trust those 9%/year average long term returns that everybody mentions. Maybe I'm just a newby at this, maybe I'm just risk adverse. Probably both. Which is why I ask.

As for the hitching, we are also looking at that. What comes first doesn't really bother me. The goal is to pay 50/50 (same as what we would get if we de-hitched on a primary residence in my jurisdiction). Our agreements would provide that she can buy me out if I default (she has the bank of daddy behind her -who may also be my mortgage lender, haven't decided.

[LivingAlmostLarge]

I think this is a bit weird, so does that mean you will have a mortgage of $75k max because GF is putting cash down? That will affect my answer.

I also don't like the bank of daddy. I would probably not buy a house with a GF until everything has been settled financially. Is she paying cash? And you get the mortgage but joint names on the deed? Survivorship or not?

Are you getting married? This to me all factors into whether to get a mortgage or not. You may need cash to buy her out, you may need cash to if you break up to sell the house. I guess it's not black and white to me becuase of the instability in a relationship.

[thekid]

Originally Posted by LivingAlmostLarge

I think this is a bit weird, so does that mean you will have a mortgage of $75k max because GF is putting cash down? That will affect my answer.

I also don't like the bank of daddy. I would probably not buy a house with a GF until everything has been settled financially. Is she paying cash? And you get the mortgage but joint names on the deed? Survivorship or not?

Are you getting married? This to me all factors into whether to get a mortgage or not. You may need cash to buy her out, you may need cash to if you break up to sell the house. I guess it's not black and white to me becuase of the instability in a relationship.

Well the relationship has been quite stable for years, we are just not married yet. It may be cultural (close to 50% of younger generation couples in my jurisdiction live in common law relationships). We have talked about mariage, will probably do it in a year or two....but it's not high priority. Looking at timing, the house would probably come first. I will settle my work status this summer (considering two opportunities) and then buy a house.

My downpayment is not affected by hers. She has a particular situation whereby she can take care of her half (whether she pays off her half now or matches my downpayment is really her choice). I just look at my half as far as the house is concerned. I am not sure why this is a problem?

[Scanner]

I am not sure why this is a problem?

I think what the majority of us feel is if the relationship goes sour, sometimes it's not easy to liquidate. Retirement savings are fairly liquidable (or at least transferable) - a house isn't.

How can you sell "half a house" to someone other than you? So somebody is going to need to buy somebody out. If you are the debt holder and she's got deed title but then pays you a sum per month for living expenses/mortgage and wants to leave. . .well, it's just complicated.

And you are right - in America at a certain point, most states will have a time period where everything becomes common ownership.

What if you die? Does your mother then get half the house? Or does she get the whole house and the debt? I'm sure the girlfriend would be just ducky with that. She's got to buy them out. See what I mean?

Anyway, more back to the financials, yes, if you have only been investing for 4 years, it's easy to get a feeling that it's going to be 10% every year - just not so. It wouildn't be unheard of to have a bear market 2, 3 years or a sudden correction that takes years to recoup.

The stock market is a weird thing. . .you can have 7 years of losses or flat lines or very slight growth and then all of the sudden - in 45 days you gain 80% or something. The problem is, you just can't time it. YOu don't know if the correction will be tommorrow or 10 years from now. You don't know when the bulls are going to rally either and that 45 days will occur.

[thekid]

Thanks for the reply Scanner, it's well appreciated.

I really didn't anticipate dying! That would put a damper on my day! We do need to think this out some more in detail. Thanks for the advise. In my mind, though, we are "as if" married. It's really just a question of putting energy by priority and planning the actual celebration hasn't been a priority. Should I die, I'd want her to get my half. I do have to check if it's ditto for her (we really didn't look at this). Should we break up, which we have discussed, she would buy me out. She has the means for it and this is what we agreed to. Should she feel more comfortable matching my cash down and being 50/50 on the debt, that is fine too. This is her choice and so far she wants to clear her half so that is what I'm going with. It may be more simple to simply go 50/50 on the cash down, however this is not great for her as she doesn't want to invest in the market and she would pay more interest on her half of the loan than she would gain interest on CDs. I don't agree with the thinking, but she has a particular familly situation and her familly is very conservative on how they invest and it has brushed up on her. How she invests however is little of my concern.

With regards to the financials of the downpayment/mortgage payment discussion (which is the advise I am seeking), I understand that markets don't return 10% a year, every year. This is where my dilemma comes in and the reason for this thread. Being somewhat risk adverse, I am more inclined to take a guaranteed 5% after tax return (saved interest) than to try to beat that by investing in the market in a tax deffered account. I suspect that I am being too conservative however and wanted feedback from people here. Basically, can I really anticipate 8%-9% average long term returns on the market (or what would be a realistic anticipated return). This would help me decide whether I'm out to lunch taking the 5% saved interest over anticipated market returns. Alot of the answers so far have provided me basic feedback on what people think and I appreciate that.

[safari]

Let's look at a specific example with numbers. For instance, let's say, your share of the purchase price is $150,000 and you got $70,000 that you can use as a downpayment.

Scenario 1. You pay down 20% ($30,000) and invest the rest ($40,000). You get a 20-year loan at 6% for $120,000. Your monthly payment would be $860. Your $40,000 that you invested in 20 years will grow to $186,000, assuming 8% average yearly return (which is a reasonable return with a mixture of mutual funds, stocks and bonds).

Scenario 2. You pay down $70,000 and get a similar loan, but for $80,000. Your monthly payment will be $573. The difference in mothly payments between scenarios 1 and 2 is $287, which you can invest every month. In 20 years with the same 8% return, you're going to have $164,353 in your investment account. This is $21,647 less than in scenario 1.

Conclusion. It's clear that scenario 1 is more beneficial. If you're able to get a better return, the difference will be even greater. For example, at 9% yearly return in scenario 1 you will have $224,176 in 20 years, while in scenario 2 you will only have $184,672. Considering the fact that mortgage interest is tax-deductible, scenario 1 looks even better.

[humandraydel]

Originally Posted by thekid

Basically, can I really anticipate 8%-9% average long term returns on the market

If history is any guide. Of course, you know what they say: past performance is no guarantee of future results. And of course, long term is 10-20 years.

If I were you I'd figure out how much of a payment I could afford even if I downshifted to a 70k salary. Then I'd back calculate the loan amount that would be. I'd then put down the difference between the loan amount and your half of the house. Then I'd invest the rest.

[thekid]

Originally Posted by safari

Let's look at a specific example with numbers. For instance, let's say, your share of the purchase price is $150,000 and you got $70,000 that you can use as a downpayment.

Scenario 1. You pay down 20% ($30,000) and invest the rest ($40,000). You get a 20-year loan at 6% for $120,000. Your monthly payment would be $860. Your $40,000 that you invested in 20 years will grow to $186,000, assuming 8% average yearly return (which is a reasonable return with a mixture of mutual funds, stocks and bonds).

Scenario 2. You pay down $70,000 and get a similar loan, but for $80,000. Your monthly payment will be $573. The difference in mothly payments between scenarios 1 and 2 is $287, which you can invest every month. In 20 years with the same 8% return, you're going to have $164,353 in your investment account. This is $21,647 more than in scenario 1.

Conclusion. It's clear that scenario 1 is more beneficial. If you're able to get a better return, the difference will be even greater. For example, at 9% yearly return in scenario 1 you will have $224,176 in 20 years, while in scenario 2 you will only have $184,672. Considering the fact that mortgage interest is tax-deductible, scenario 1 looks even better.

Thank you for this Safari. I really appreciate you taking the time.

However, I would also have to include additional saved interest into scenario 2 (I can make the loan period shorter (15 vs 20 and hence "contributing" the full mortgage payment for the last 5 years...albeit the difference in mortgage payments for years 1-15 will be smaller).

Also, my max 2007 Canadian "IRA" contribution will only be of 22k-25k (taking into account unused portions of prior years). Should I max that, 2008 max contribution will only be circa 10K (from my budget calculations, I will have yearly savings around 6K marked for my "IRA" equivalent account...leaving only 4K a year space to use the 15K-18K "leftover"...so it would take a little less than 5 years to fully invest the 40K in a tax differed account, meanwhile "leftover" returns would be taxed until they can be put into IRA). This will affect the numbers some. Also, mortgage interest is not tax deductable in Canada.

If I take into account that the 8% return will not be linear (and therefore, should the first years have returns significantly lower), this could significantly affect the amount accrued in 20 years.

But I do get the point. Basically, 8% starting now on a larger sum is better than 5% starting now on the same sum, plus 8% on the mortgage payment difference.

If I trust the 8% (or higher) return, I should limit my cash down to 20%. Plus, I have to stop thinking that lower mortgage = greater flexibility as greater flexibility is obtained from cash on hand (or where it could be reached). This is finally sinking into my thick head. Thanks!

[thekid]

Originally Posted by humandraydel

If history is any guide. Of course, you know what they say: past performance is no guarantee of future results. And of course, long term is 10-20 years.

If I were you I'd figure out how much of a payment I could afford even if I downshifted to a 70k salary. Then I'd back calculate the loan amount that would be. I'd then put down the difference between the loan amount and your half of the house. Then I'd invest the rest.

That is what I did. I would love 650$/month payments. What I have to play with is the lenght of the loan. At 70K down, 650$/month is a 15 yr loan. At a lower downpayment, I would take a lenghtier loan.