Talk me down...

[disneysteve]

Mr. Money has $200k invested in a diversified, tax efficient index fund portfolio. He is about to purchase a $200k home and has asked your advice. He can easily afford the payments on a $200k mortgage. What do you suggest?

A. Liquidate all investments and pay cash for house.
B. Put 20% down and finance 80%.
C. Finance 100%.
D. Put 50% down and finance 50%.

What would be the interest rate on the mortgage?

Just because the portfolio is in tax-efficient funds doesn't mean there wouldn't be tax consequences to liquidating the investments. There would be capital gains to pay for sure so Mr. Money wouldn't net 200K. He would also be left house poor with all of his money tied up in his home, which I wouldn't recommend. So I wouldn't pick A and I would never under any circumstances approve of C.

So what's the difference between B or D and doing a cash-out refi? With option B or D, you are keeping investments you already have and borrowing money to buy a house. With the refi, you are borrowing against your home's value to buy investments you don't already have. Maybe on the bottom line, it works out the same. It just feels very different to me.

I guess what would really decide it for me is if the person needed the investment performance to make the loan payments. If my portfolio crashes, I can still keep up my mortgage payments because they are made from current income. If someone borrowed from their equity to invest and could comfortably afford the loan payments no matter what happened to the investments, I guess there really wouldn't be any difference.

[LuxLiving]

disneysteve, educate me/us. Why would you never finance 100%?

[disneysteve]

disneysteve, educate me/us. Why would you never finance 100%?

I think that takes a big, unnecessary risk. Look at the current housing mess. People financed 100% of the purchase and then the value of the home dropped 10 or 15 or 20%. Now they are stuck in a home that is worth thousands less than they paid. They can't sell because they wouldn't get enough to pay off the mortgage. Even worse are the ones who used creative financing hoping to sell or refi before payments shot up, but that is a seperate issue.

If you bought a 300K home with 60K down and a 240K mortgage, even if the home dropped in value by 20%, you'd still be able to get out if you had to (assuming you could sell the place of course). If you bought that same 300K home with a 300K mortgage and the value dropped to 240K, you're screwed unless you can come up with that 60K on your own. I suppose if you kept that 60K invested somewhere and could access it if you needed to, that would work. Just not the way I would advise doing things.

I guess I'm just more traditional and conservative.

[Snave]

Let me throw a wrench into this and I would like your thoughts. Let's say it was closing in on the time allowed to contribute for 2008 and this same scenario was thrown out. So, by taking out money on the HELOC, you could make your 2008 contribution knowing that you could pay back the HELOC in a short time period (it looks like he said he could do it in a few months), but NEVER get the opportunity to invest in a ROTH for 2008 again. Does that change things? That is many years of tax free earning that you might not otherwise get back. Just a thought.

[disneysteve]

Let me throw a wrench into this and I would like your thoughts. Let's say it was closing in on the time allowed to contribute for 2008 and this same scenario was thrown out. So, by taking out money on the HELOC, you could make your 2008 contribution knowing that you could pay back the HELOC in a short time period (it looks like he said he could do it in a few months), but NEVER get the opportunity to invest in a ROTH for 2008 again. Does that change things? That is many years of tax free earning that you might not otherwise get back. Just a thought.

I would do it. As you say, you can never make up for missed Roth contributions. In fact, the more I think about, the more inclined I am to say to go ahead and do it in the original scenario.

[Snave]

Thanks Steve. I put the hypothetical to this situation, but it might be me that does this at the end of 2008. We just put the patio in and I am in need of a new car (I will NEVER by American again! I have sunk more money in to this Lincoln than I care to share!). Since I really don't enjoy debt, I will probably pay cash for the car and suck it up and have a little debt for a few months in 2009 if I go ahead and fund the Roth using the HELOC. I do not know if I will have the cash to fund it in 2008 and have everything else paid off also. The interst rate will be better with the HELOC than a loan would be if I took one out for the car so that is why I am leaning this way if it happens. Now before maat55 tells me to buy less house and and toys like the IMO so that I can invest properly, I am maxed in my 401k this year. We also typically save more than 30% of our income in a given year. 2008 just happens to be one of those years where everything seems to be hitting (and with a lot of zeroes on the end)!