Ever since we put the purchase agreement in on our house, Mr. NTF and I have been discussing how much of a down payment to put on the house. This is a topic that interests me on both a practical basis as well as theoretical. Here are a few of our options and some of the questions that arise with each option:
Option 1: Standard 20%
Pros: With 30 year mortgage rates below 4%, this would be taking out the largest loan possible at this ‘low’ rate. Taking our a larger loan also leaves us with more money in liquid savings.
Cons: Increases our monthly fixed costs. It would be a huge stretch to afford these monthly costs on only one of our incomes. While we could do it in an emergency, it would not be ideal on an ongoing basis.
Option 2: Put down more than 20%. We’ve talked about putting down more than 20% but putting down more than 20% but less than 100% leaves a large range. The amount we’ve been considering is an amount that would keep our overall housing costs similar to what they were in our condo.
Pros: Keeps our monthly fixed rates low and at an amount easily affordable on one of our incomes. With a smaller mortgage, we’ll pay less interest over time and have a smaller loan balance to pay off in the future. With a smaller loan we would also pay lower loan origination fees as many of the fees are based on the size of the loan.
Cons: Ties up more cash.
Questions: What’s the optimal amount to have in liquid vs very illiquid assets? In other words, not including retirement savings in non-taxable accounts, what percentage of your money do you need to keep liquid?
Option 3: Pay cash
Pros: No mortgage! No mortgage application fees, which I’m slowly finding out are surprisingly high.
Cons: The biggest con is that this isn’t a viable option for us at this point. But I’m hugely interested in the topic from a theoretical perspective. Are there any cons to paying for a house in cash? I’m expecting someone will say that with interest rates this low, you can make more money putting your money in the market. But can you really? This certainly has not been the case recently and then there is also the issue of expected return in the market vs a ‘guaranteed’ return’ of paying down your mortgage.
Questions: This option brings up similar questions as Option 2. How much of your net worth should you keep liquid? Do you need to keep less money liquid if your paying cash since you would not have a mortgage and your fixed costs are lower? Interest rates are low but I keep hearing in the news that there are cash buyers in the market, so it must be possible for some people and it also must make sense for the right buyer.
At this point we are leaning towards option 2 rather than option 1. We were able to afford our condo on just one of our incomes and I like the idea of keeping our fixed costs low. We would tie up more of our net worth in the house, but we would still have a strong emergency fund.
Very curious to hear your thoughts on this topic if you them! How much of your liquid net worth would you tie up in your house? With 30 year mortgage rates below 4%, would you even consider putting down more than 20% on a home?
This is something that I have been thinking about as well. I know that I’m putting a minimum of 20% down, but if I buy something lower in my price range, will I put more than 20% down?
I would definitely consider putting more than 20% down on a home! The approximate dollar amount that I’m planning on putting down isn’t really changing despite the price range going up or down. Ideally, right now, I don’t want to have more than 40% of my net worth tied up in home equity. I will watch that number before I start making pre-payments on a future mortgage.
I’m curious to hear what you guys end up doing as well
Are you thinking of 40 percent of your total net worth? Including 401k and everything?
Yeah, 40% of my total net worth if you add up checking accounts, cash savings, 401(k), IRAs, and taxable investments. That will get better over time, but with the price of places and my desire to put 20% down, that’s really what it’s looking like.
For us, diversification is important. We don’t want 100% of our money tied up in one piece of real estate. So mortgage prepayment goes along with retirement savings and cash savings. We consider the house to be part safe investment (since it’s paying off debt and we’re unlikely to foreclose) and part real estate investment.
We could pay off our mortgage, but that would wipe out our secondary emergency fund of taxable investments. We could stop mortgage prepayments and direct that money towards retirement, but that would put relatively way too much money into assets that we can’t touch for another few decades.
This is interesting- so you could pay off your mortgage right now but are choosing not to. I agree that all your net worth should not be in your house. Do you have any targeted percentages for house, retirement, taxable? I’d be interested in hearing more about a secondary emergency fund.
No targeted percentages, I think of things in terms of months of living expenses. Our situation is kind of unique in that we can’t be fired without a year’s notice (and now I can’t be fired unless I commit a felony or they dissolve my entire department).
So we have 1-2 months in cash, a little over 1 year in the taxable stock market that we bought in graduate school from our rent savings when we worked as RAs. We have a LOT in tax-advantaged retirement funds– that’s the bulk of our money. For that money I prefer to have it automatically deducted and just forget about it except once a year or so when we see how we’re doing.
Over the next two years we’ll be shifting new money into easier to access assets (cash, the house) as my husband is unlikely to get tenure and we need more tappable money because of that uncertainty.
Here’s a post on why we don’t just pay off the mortgage: http://nicoleandmaggie.wordpress.com/2012/04/02/april-mortgage-update-and-comments-on-a-minting-nickels-post/
In general here’s our mortgage tag: http://nicoleandmaggie.wordpress.com/tag/mortgage/ We talk about housing and the big picture about once a month along with the update on my mortgage. (#2 on the blog has student loans but no mortgage.)
Wow, congratulations – as financial problems go, this is a pretty nice one! First, I don’t think there is one “right” liquid/illiquid ratio. It depends on what stage of financial life you’re in. Early on, if you’re paying off debts, building up your emergency funds, but just getting started with long-term retirement investing, you’ll be relatively very liquid. Several decades later, just approaching retirement – house paid off, retirement savings consistently built up – the ratio will be the other way around. Same household, same strategy, but very different ratios at different stages.
But your real question is: option 1, 2, or 3? Once again, I think a lot depends on which part of your financial life you’re in. I just happened upon this blog so I don’t know where you and Mr. NTF are, but let’s say you’re each 30, and plan to work until you’re 60. That means that you have the wonderful advantage of a 30 year investment horizon, which gives you an enormous edge over most other investors. I understand your reservations about the stock market, but a 30 year horizon allows you to invest in the highest returning type of investment VERY safely – by spreading your purchases over a very wide span of time and a very wide variety of market conditions. Buy very widely diversified, very low cost equity index funds, in a tax advantaged account, on a very regular basis, over a 30 year span – and then sell them the same way (gradually) once you retire – and you’ve taken nearly all the risk out of the equation. This opportunity means that option 1 is the way to go ¬– it frees up the maximum amount for you to invest this way. As Nicoleandmaggie noted, that’s WAY less risky than putting a huge amount into ONE asset in ONE market all at ONE time. (But, I’d NEVER advise less than 20% down, so I’m glad you didn’t list that as an option! Even if the lender would allow it, 20% eliminates PMI, and gives you a healthy amount of downside price protection.) But if you and Mr. NTF are much further along and looking to retire next year – I’d probably advise something very different. Good luck!
Thanks. While I agree with everything you said here in theory, when I think about it with respect to my own life I have a hard time with two things. 1) If I take out a 30 year mortgage I’m committed to similar income level for the duration, unless I buy a house that is much much less expensive than I can afford. 2) Unfortunately, I also have a hard time believing a stock and bond mix will give me significantly over 4%. Yes, I’ve just been that jaded over the past few years. And paying down a mortgage early gives guaranteed return vs an expected market return. Luckily we still have a few more weeks to wrestle with this decision.
I put about 6% down on my apartment back in 2009. Worked out well. But then again, we probably live in completely different cities. With even lower interest rates today I would still use less than 10% for a downpayment if I were to buy a second home. Lock it in for 30 years and invest the savings instead. I think there’s a pretty good chance that a balanced portfolio of stock and bonds can average over 4% over the next 30 years.
Putting more than 20% is not going to lower your interest rate, just your payment. If you can’t afford the payment after putting 20% down, then you are buying too much house IMO. You should of course expect to increase your salary over your career, but definitely foresee a reduction if you plan a future career move that puts you in a lower salary bracket and take that into consideration with regard to home prices. Temporary joblessness should be leveled by an emergency fund large enough to calm those fears. I’d choose option 1. Keep your money liquid and when you feel comfortable you can prepay later (again putting more than 20% now will do nothing to lower your interest rate unless you’re trying to avoid a jumbo loan).
Don’t worry, I definitely understand that, beyond staying below a jumbo mortgage, putting more down does not lower your interest rate. I am fairly certain we are not buying too much house. We can afford the payments putting 20% down on only one of our incomes, but it would be tight. I want to put enough down that we could comfortably afford the house on one income.