Saving for a new house

[tmauch]

I bought my first house a little more than two years ago. For awhile, I made enough extra payments to basically equal two full extra payments a year. However, in December I had a plumbing emergency that required me to dip into my emergency fund. In order to restock my emergency fund, I stopped making the extra mortgage payments. My emergency fund is now replenished, and I started thinking about making the extra payments again. However, the more I think about it, the more I wonder if that's the best use of my money. I would like to buy a new house four to five years from now (this is a starter home and I do not want to be here long term.) I owe about $87,000 on it at 5 percent interest. Even making extra payments, I won't have that much equity built up (I have about $5,000 right now). Does it make more sense to make those payments or take the money and put it in a savings account that I would use for a down payment on the new house? I'm not sure if those extra payments will save me enough in interest to make it worth it. Thanks!

[bjl584]

If I were planning on moving in a few years, then I probably wouldn't make extra payments on the loan. Just pay what you owe and take the extra money and either save or invest it.

[disneysteve]

If I were planning on moving in a few years, then I probably wouldn't make extra payments on the loan. Just pay what you owe and take the extra money and either save or invest it.

I agree. Use that extra income to build up your savings.

[phantom]

I hate to disagree with bjl584 bjl584 and disneysteve because their advice is usually pretty good, but I would pay extra on the mortgage. I figure that for every $100 you have, your options are putting it on the mortgage where it would save you $5 in interest per year or putting it into savings where it would earn you $1 in interest every year. So, ignoring compound interest so I can do the math in my head, when you sell in 5 years, you could either have $125 extra in equity on your house or $105 extra savings in the bank. I'd rather have $125 extra in equity.

The only advantage I can think of in having the money in savings rather than in equity in your current house is flexibility. If there's any chance you'll want some cash to fix up your house before you sell or buy a new house before you sell the first one, having some cash on hand could be useful. Perhaps I'm overlooking the value of flexibility by telling you to pay extra on the mortgage.

[disneysteve]

The only advantage I can think of in having the money in savings rather than in equity in your current house is flexibility. If there's any chance you'll want some cash to fix up your house before you sell or buy a new house before you sell the first one, having some cash on hand could be useful. Perhaps I'm overlooking the value of flexibility by telling you to pay extra on the mortgage.

Exactly the reason I wouldn't pay extra. What happens when you go to sell your current home and the inspector hands you the list of items that need to be repaired? What happens if you find the ideal home but haven't sold yours yet? Yes you'll lose a little interest by not prepaying but there is potential opportunity cost from having all of your cash tied up in equity that you can't access.

[bjl584]

The only advantage I can think of in having the money in savings rather than in equity in your current house is flexibility. If there's any chance you'll want some cash to fix up your house before you sell or buy a new house before you sell the first one, having some cash on hand could be useful. Perhaps I'm overlooking the value of flexibility by telling you to pay extra on the mortgage.

Here is one more advantage that I can think of off the cuff. Let's use $1 to keep the example simple. So then, let's say I pay $1 extra into my mortgage loan. Now let's say I sell the house. I may or may not realize that extra dollar at the end of the selling process. You can't be 100% certain what repairs the house may need, or what the house will sell for, or what closing costs or tax issues may arise. On the other had, if I put that $1 in my savings account instead I would have that $1 to use later for whatever. That would be guaranteed.

That, and interest rates are currently so low, it wouldn't be that hard to earn more on your money someplace else as opposed to paying down a mortgage early.

[tmauch]

Thanks for all the feedback! I think I'll start saving the money.

[parafly]

The answer can vary depending on your specific circumstances.

I noticed that your balance is currently $87K, and you only have about $5K in equity. Based on these numbers, there is a good chance you are currently paying PMI. If so, you are probably better off paying down the principal and trying to eliminate your PMI payments as quickly as possible.

Another consideration is taking a balanced approach. Why put all your eggs in one basket? Putting half of your extra funds into savings and half into the principal of your house could be an effective strategy that covers all your bases.

[Emerald]

I'm in the same situation, with roughly the same numbers. I'm splitting the difference. I send the equivalent of an extra payment a year, then I save the rest.

[ecoadapt]

Thanks for the post, this could help many people on how to start saving their money.

[Max G]

If you know that you are going to be moving in the next couple of years, I would save up money instead of pre-paying your mortgage. Yes, you probably wouldn't make 5% on the money saved but extra flexibility of having cash-like money is well worth it.