100% Down Plan

[dczech09]

One more thing: your illustrations above assume a 5% APR on the mortgage. Right now, that is a low rate and will only be available to those with good credit. We all know where interest rates are heading: UP! By the time I get to my decision point, we will likely be back at 6% or 7%; this makes the numbers detailed above mute.

Also I ran the numbers and I calculated $10,000 more in interest being paid out assuming that 5%. Not a big deal, just thought I would mention it.

[disneysteve]

you have to get an 8% return to recover from a 4% loss

Thankfully, that isn't true.

$1,000 - 4% loss = $960

$960 + 4.167% gain = $1,000

[Tobby782]

More People Should Do This

More people should save 100% down to buy a house. It's hard, but can be done. Decades ago there were more people that followed this course.

[disneysteve]

More people should save 100% down to buy a house. It's hard, but can be done. Decades ago there were more people that followed this course.

I wonder if that is true. My parents bought their house in 1955. They had a mortgage. They did repay the loan in 5 or 6 years as I recall but they didn't buy for cash. I think my dad got some loan as a WWII vet.

[dczech09]

Thankfully, that isn't true.

$1,000 - 4% loss = $960

$960 + 4.167% gain = $1,000

Ok so I may have made a false statement there. But say you have a 50% loss, you would need a 100% return to recover. The recovery differential is exponential; guess we're getting into calc now

[Shewillbemine]

You know, the ironic part to all of this is that we're throwing around a number such as $200,000 as if it were some easily attainable number that can be saved with super aggressive saving.

Oh I have no doubt that a FEW people can willfully save this much and then decide to buy a house outright but several realities come into play:

-Depending on the area you want to live at, $200,000 can buy you an entire house or a basement. Where I live, $200,000 will buy you a 1 BR condo in a not so nice part of town.

-A lot of people spend their entire lives or close to it to save this type of liquidity. So unless a magical windfall appears in one's bank account, theoretically you could be well close to retirement age before you gave yourself the chance to purchase a home and enjoy the intangible benefits of home ownership.

-Historically, when approached correctly, home ownership + financing the loan have reaped many benefits (dollarwise) to those who could only afford the traditional route of 20% down and paid several years of mortgage. Home ownership, as a whole (and I'm sure the boo birds will jump on this statement), has proven to be a very good investment.

-I actually am friends with a few millionaires and have clients who are on the threshold of billionaire status (I've worked with the folks in the "Gucci House" overlooking the Pacific Ocean, aptly named because Gucci used to own it, I've worked with the former owner of Edwards Cinemas, I've worked with someone who had, yes, a helicopter in his backyard) and most of them find much more lucrative investments to work with than 100% home purchasing. But then again, what do millionaires know about money, investments and financing?

[littleroc02us]

You changed the examples I gave, so you're no longer comparing apples to apples.

Let me try to simplify, I believe the only part I messed up on was using the tax info or not. I will use your original numbers again. So here are your original numbers with a more realistic approach to see what you think. I agree the the person would put 20% down in order to avoid PMI.

Two people age 30 and married have 200k in their pocket and want to buy a house and have 30 years until retirement to save. Both users have an EF fund of 3-6 months and have no outstanding debt. Both will be in the 25% tax bracket when they retire.

Scenario #1
Person A wants to take out a mortgage for 30 years @ 5% and put 20% down to avoid PMI.
Person A wants to take the remaining 160k and invest it in Mutual funds for 30 years getting a return as you stated of 8% never putting any more in.
That comes out to these figures for the house:
-Monthly payment=$1025.58
Which includes:
-Interest=$149,209.25
-Taxes=$60,000

Investments:
Mutual Funds=$1,610,025.10 X 25% = $1,207,518.82. (This is a rough estimate because I'm not going to do it year by year)

*When you retire you will be taxed for your withdrawls @ 25% which is approximately $402506.28.

M
Scenario #2
Person B is going to pay cash of 200k for a new house and invest what he would have been paying for mortgage and interest into a roth IRA and mutual funds for 30 years and getting a return of 8%.

-User pays 200k for house
-user pays taxes of $60000 on house for 30 years.

Investments:

Mortgage payment now used for investing=$858.91 (doesn't include tax money because your paying it as you go)

Roth IRA's 10k a year for 30 years=$1,250,245.98 tax free withdrawls, which is investing $833.33 each month. That leaves $25.58 to invest each month into mutual funds which at an 8% rate of return for 30 years is $3.198.13. This would be taxed also @ 25% which leaves $2398.60. (This would be funny because you would do something with it.)
-Total investment after 30 years then would be= $1,252,644.58



The end result is this with more accurate then my last post.

Scenario #1 $1,207,518.82 (Risk level is off the charts/Not reflective in result)

Scenario #2 $1,252,644.58 (conservative approach reeps higher rewards)

[disneysteve]

You know, the ironic part to all of this is that we're throwing around a number such as $200,000 as if it were some easily attainable number that can be saved with super aggressive saving.

Actually, OP is talking about saving $100,000 and projects doing so in 6 years. If OP lives somewhere where 100K buys a home, this isn't an unreasonable goal at all.

[littleroc02us]

What I was talking about is either A) paying rent and saving money for a 100% down payment or B) taking out a mortgage. My strategy would involve saving for the 100% down payment while simultaneously investing for retirement. Totally different from what the topic has changed to.

On a side note, if I did have $200,000 at my disposal, I would buy the house 100%. The reason is simple: its less risky. All of the illustrations shown above do make sense by do not account for potential market flucuations for both the house and the mutual fund investments.

F

we were just having nerd fun running what ifs. I think you should do option A. Take your time and do it slowly. I think to myself all the time about selling my house and renting for 5-6 years and piling up cash to by a house outright, because when you have a mortgage it moves so slowy and you feel like your wasting investing dollars on interest and taxes. The problem is that we love our house and our neigborhood is amazing, so it's kind of a give and take.
Have fun with it.

[littleroc02us]

-I actually am friends with a few millionaires and have clients who are on the threshold of billionaire status (I've worked with the folks in the "Gucci House" overlooking the Pacific Ocean, aptly named because Gucci used to own it, I've worked with the former owner of Edwards Cinemas, I've worked with someone who had, yes, a helicopter in his backyard) and most of them find much more lucrative investments to work with than 100% home purchasing. But then again, what do millionaires know about money, investments and financing?

Read the book "The Millionaire Next door" and you will find that's not true. Most of the nations self made millioniare's have a low realized income, large networths based on their assets and no debt.

[jpg7n16]

What I was talking about is either A) paying rent and saving money for a 100% down payment or B) taking out a mortgage. My strategy would involve saving for the 100% down payment while simultaneously investing for retirement. Totally different from what the topic has changed to.

That is a slightly more involved question, that primarily depends on what level of house you're looking to buy, and what level of rent you would pay in the meantime.

There are a wide assortment of things to consider. You must consider the total cost of ownership of the house vs total cost of renting.

Renting is easy: rent + renter's insurance

Home ownership is more complex:
-mortgage payment
-interest rate (tax-adjusted)
-PMI (if needed)
-taxes
-homeowner's insurance
-HOA dues (if applicable)
-maintenace costs (watering and mowing yard, basic home repairs, etc.)
-major home repairs
-real estate value risk (houses can go either up or down in value)
-large illiquid asset (hard to sell if in a bind)

In the end you just need to compare savings. Is the cost of renting lower than the total cost of homeownership by more than the tax deduction + equity of mortgage payments.

On a side note, if I did have $200,000 at my disposal, I would buy the house 100%. The reason is simple: its less risky. All of the illustrations shown above do make sense by do not account for potential market flucuations for both the house and the mutual fund investments.

The fluctuations of the home don't matter. Because they affect a home buyer equally whether they borrowed the cash (mortgage) or had the cash to buy it. So since home fluctuations affect both buyers equally, they're not included in the calcs.

And the 8% over 30 years has the fluctuations calculated into it. The 8% is a compounded average used, which is a conservative average of the market returns over similar periods.

The fact that actual returns are 10%, 5%, -12%, 23%, etc. year by year makes no difference. The 8% accounts for that variance.

For instance, if the stock marke plummets, the person who bought 100% down while systematically investing money will reap the benefits of dollar cost averaging. The person who financed the mortgage and invested the $200,000 sum would have a big bite taken out of their portfolio that will not recover as easily (you have to get an 8% return to recover from a 4% loss).

This was noted in my calculations.

But you'd have to have the market plummet for 30 years - and historically, that has never happened. Not saying it's impossible, only saying it's very unlikely.

Also risk would make things extremely tough if a job loss were to occur. There is the possibility of doing an early liquidation of the mutual fund to pay off the mortgage if a job loss occurred, but who says the portfolio would necessarily have a gain.

The point is this: the person with no debt will have a lot more control over crisis mangement and will not run into problems that a mortgage holder has. Lets face it, the number one cause of foreclosures today is mortgages .

The scenario was given above, it's less risky in event of a job loss to have a $200k portfolio and a mortgage, than to have no mortgage and no portfolio.

It's hard to foreclose on someone who has $200k available to pay his mortgage for a year while he's out of work. This person could last 200 months of a $1k mortgage payment. That's 16 years. I'd assume they could find work in that timeframe. (and they'd be building equity in their home the whole time, while out of work)

The number 1 cause of foreclosures isn't a mortgage alone. It's a combination of a mortgage and a lack of liquid assets.

True 100% of foreclosures had mortgages. But it's also true that 100% of people who continued to pay their mortgage weren't foreclosed on.

Also what is with people praising the tax deduction that mortgage interest provides? Elementary math will tell you that if you the option to be debt free, you be debt free. While yes a mortgage tax deduction will LIMIT cash outflow, it should never be a used as a deciding factor as to whether or not a mortgage should be used. Last time I checked, a person with no mortgage will have a lower outflow of cash. Personally I will take that over sending money to a bank; at least I will be financing my own ROI and not the bank's.

The tax deduction lowers the interest cost. And thus increases the gap between interest cost and investment earnings. So while a 5% mortgage costs you 5% interest, it gets a 25% tax write off - effectively become 3.75% interest.

The statement in blue is not true as it's very shortsighted. It does not account for risk tolerance at all.

Because true, elementary math will tell you that 0% is better than -3.75%.

But it will also tell you that 4.25% is better than 0%. (8% gains - 3.75% interest cost = 4.25% gains)

So (if I can tolerate the risk), it is to my benefit to earn 8% while paying 3.75%. If I didn't have the 3.75%, I could not have the 8% either. Because if I have $200k worth of investments earning 8%, and a $200k mortgage costing 3.75% after tax breaks. In order for me to stop the 3.75% charges, I'd have to stop the 8% earnings too.

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Businesses borrow money through stocks and bonds because they can pay 5% on a bond, invest that money in their business and earn 12% profits. That makes more money than they would have without the bonds. They pay low and earn high.

Debt free does not necessarily equal maximum profit. No matter what Dave Ramsey implies.

[dczech09]

Oh I know that despite what Dave Ramsey says, no debt does not mean maximum profit. And I do understand the business of leveraged investing.

Where I am coming from is a risk standpoint. Let's look at a 'housing crisis':
- Person A bought the house for $200,000
- Person B took out the mortgage for $200,000 and invested the cash instead
If the housing market tanks again (which I'm sure it will someday), and the house in question drops from $200,000 to $150,000, then the following would:
Person A
$150,000 house (ASSET)
$150,000 house (EQUITY)

Person B
$150,000 house (ASSET)
$200,000 cash (ASSET)
$200,000 mortgage (LIAB)
$150,000 house (EQUITY)
So both people have really broken even on the balance sheet level.

I think the whole "not having $200,000 in liquid cash" argument is very short sighted. The person who has no mortgage has cash flow on their side. They will be able to systematically invest and take advantage of dollar cost averaging, which has significant effects to building an investment.

Not having the $200,000 in liquid cash because I bought the house for cash is mute because I will have an emergency in place already. Also, retirement savings will not be sacrificed so that is mute as well. Basically I will be at the same place Person B is at except I will not have a mortgage. Person B may have a large chunk of cash, but they also have a liability that is eroding value. I will have cash flow and no debt to worry about while I am generating value.

Taking out the $200,000 mortgage and investing the cash is the same thing as leveraged investing. Person B is borrowing money at a 10% return, which generates a 7.25% after-tax return (10% - (1 - 25% tax rate)). After taking out the 5% cost of debt, that is 2.25% which will not even cover inflation. Person A will have taxes and inflation, but no cost of debt to worry about.

This is a really interesting topic because the number we're using are fudged first of all, and secondly it will depend a lot of where everybody live. I live in Appleton, WI which boats a very low cost of living. If/when I move back to my hometown of Saint Cloud, MN, I will be dealing with similar costs of living. As for someone who lives in New York or Ann Arbor, they have totally different stories.

I will have to do a more thorough analysis based on REAL numbers. Also, we should take into consideration that mortgage rates will not stay this low. Ultimately it comes down to this: Person A will have an opportunity cost of buying the house with cash while Person B has the risk of losing on an arbitrage deal. Really, there is no easy answer.

[dczech09]

I will also add that even with a 3.75% effective interest rate due to tax deductions, that will still barely generate a return after the smoke clears. Remember, borrowing at 3.75% still results in a larger cash outflow that not borrowing at all. I would rather not having had borrowed any money than take the tax deduction.

[Tobby782]

More People Used To Do This, So Why Not

It's a worthy goal, if you can get it done. True some people would point out the advantage of using some financial leverage, but you will always sleep well knowing that no creditor can ever take your home away. Many decades ago the 100% down model was more common, it should be applied by more home buyers now too.

[dczech09]

I'm gonna take some time and do a more in depth study an analysis. I'll assess different strategies such as saving and buying vs a mortgage and the whole leveraged investing strategy that has been outlined.

The more I think about, there is a slight financial benefit to taking on a mortgage and investing the lump sum of money. However, I do concur that it would be awfully sweet to sleep at night knowing a creditor can't come after me. Ultimately its a dream to simply not have debt whatsoever