100% Down Plan

[LivingAlmostLarge]

Wait how does rent factor into this as a hedge against mortgages which are fixed payments? If you take x amount of time rent goes up and how does that work?

Littleroc, it doesn't account for you trying to make the $200k invested into taxable accounts and $200k paid for home into a Roth IRA. That isn't a fair comparison, because you could argue that maybe someone investing $200k can pull out a minimum amount per year. It depends.

[littleroc02us]

Wait how does rent factor into this as a hedge against mortgages which are fixed payments? If you take x amount of time rent goes up and how does that work?

Littleroc, it doesn't account for you trying to make the $200k invested into taxable accounts and $200k paid for home into a Roth IRA. That isn't a fair comparison, because you could argue that maybe someone investing $200k can pull out a minimum amount per year. It depends.

I was just using the posters numbers, that's the situation he gave. So, in fairness then what percentage would you use for Risk? Having a mortgage will increase your risk ten fold, will it not?

[jpg7n16]

Having a mortgage will increase your risk ten fold, will it not?

Nope.

It's hard to quantify risk like that.

If we're talking about the same house, both a cash investor and a mortgage investor would be subject to market risk on the value of the home - in identical proportions.

The only real risk is that investment returns are negative, or are less than interest costs. There has never been a 30 year timeframe where the return on stocks is negative. There have been plenty of single years here and there, but never a 30 year period that ended lower than it began. So it's not guaranteed that you'll make money over 30 years, but it's very likely.

Then the question is how to quantify the risk that returns will be lower than interest costs - which is hard to do.


But can anyone say the risk is 10-fold? I don't think that's reasonable.

Yes you are taking risk by trying to earn investment returns higher than interest costs. But the way you put it is like it's a super high risk situation, when it's not really. It is higher risk, but not insane risk.


There are also risks of being cash poor because you have too much of your liquid net worth tied up in your home (as discussed earlier). An unfortunate event would be to take all your cash (except 3-6 months) and purcahse a home - then lose your job in the next 2 months before you're able to build up any liquid assets. If you're not able to find work soon enough, you'd be forced to sell the home to get access to the principal - and likely at a loss. (the bank wouldn't let you borrow against the home, since you'd have no income to qualify for the loan)

Now that's an unlikely event, true. But it's also unlikely that investment returns over 30 years will be negative.


It is a decision best made when considering what your personal investment risk tolerance is. Your investment risk tolerance is low, so if you built up enough cash to buy the home outright (what the OP is attempting to do) once you had the cash, you personally should buy the home rather than get a mortgage and invest the cash into stocks.

[littleroc02us]

Nope.

It's hard to quantify risk like that.

Your wrong, because someone with a mortgage vs. someone with a paid for home aren't the same. Chances are greater for someone with mortgage everytime, so with your logic you should go into retirement with a mortgage then, because there isn't a risk right even though you don't have a job and are counting on your investments to carry you. Even if you aren't retired and working still, you have nothing but cash flow coming in vs. someone who has to pay their mortgage each month. What don't people get about that?

[jpg7n16]

Your wrong, because someone with a mortgage vs. someone with a paid for home aren't the same. Chances are greater for someone with mortgage everytime, so with your logic you should go into retirement with a mortgage then, because there isn't a risk right even though you don't have a job and are counting on your investments to carry you.

Usually, retirees change the makeup of their portfolios to ensure consistency of income - thereby reducing expected returns on their investments. Which narrows the gap between investment earnings and interest costs.

If I was able to secure a mortgage @ 1%, I would absolutely hold the mortgage as long as possible, and invest any extra I could have paid on it. Retired or not.

Why should I stop my bonds from earning 5% if interest only costs 1%?? That would cost me 4% a year.

A young investor (just beginning mortgage = young) has 30 years to go, so can take more risk and hopefully earn more. An older investor doesn't have 30 years to go any more and needs more security of funds. Not complete security, just more.

So the young investor could earn 7-11% while the older investor may only earn 4-7%. And if interest costs are 5%, it makes much more sense for the younger investor to try for 7-11% while paying 5%, than it does for the older investor to try for 4-7% while paying 5%.


We're not advocating 'hold any debt you can and invest instead' we're advocating 'if the interest rate is low enough, it may be worth the risk.'

If mortgage rates were 10%, no one would be arguing against a paid off home. If mortage rates were 0%, many more people would see the advantage of investing rather than paying down the mortgage.

Even if you aren't retired and working still, you have nothing but cash flow coming in vs. someone who has to pay their mortgage each month. What don't people get about that?

Even if you have a mortgage, your investments are earning more each month than your mortgage payment costs you each month. What don't you get about that?

[littleroc02us]

Even if you have a mortgage, your investments are earning more each month than your mortgage payment costs you each month. What don't you get about that?

Actually that's not true because I've already done the math on both scenarios and the paid off mortgage idea comes out better in the long run. Just look at my post from before. When you have debt vs. no debt you always have more risk. No one can dispute that.

[jpg7n16]

Actually that's not true because I've already done the math on both scenarios and the paid off mortgage idea comes out better in the long run. Just look at my post from before. When you have debt vs. no debt you always have more risk. No one can dispute that.

Oh you mean this post (quoted below) that was based on faulty math? I have two main problems with the process you used to come to your conclusion:

1) Why did you only consider the Roth IRA for your preferred method, while ignoring this possibility for the mortgage holder? Can they not move $10k from their investments to their Roth each year? Why did you give 1 scenario tax free withdrawals and not the other?

You should have evaluated them on the same tax basis. Either both get to use a Roth, or neither get to use a Roth (ex. they are already maxing out their Roth accounts as part of saving for retirement, so this housing cash flow cannot be put in a Roth).

In my example, I evaluated both scenarios without the use of a Roth IRA.

2) Even though you say you won't consider the taxes, you still include them in the payment amount of $1,281.98. Your second scenario - you let the individual invest the amount for taxes and PMI. (833 + 448.98 = 1281.98)

The actual mortgage payment is only $1073.64. And 0.5% PMI is $1000/year ($83.33/month).

And $1073.64 + 83.33 = $1,156.97, not $1,281.98.

Although your words said you weren't accounting for taxes, your math says otherwise. Once you back out the Taxes from the equation (like I did in my calcuations posted earlier and quoted below) - you'll see that the mortgage investor comes out well ahead.

I didn't even give the mortgage investor his tax deduction each year, or allow him to invest that refund, or allow him to invest the PMI payment after an 80% LTV ratio is reached - and he still comes out ahead.

For example, consider these two scenarios.

Scenario 1. A guy buys a house for $200,000 and finances the entire amount ($200,000) at 5% APR for 30 years fixed, even though he has $200,000 in cash, which he decides to invest into stocks and mutual funds. Every month he pays $1,074 to the bank and doesn't make any additional deposits to his investment account. In 30 years he would have the house paid in full and he would also have $2,012,531 in his investment account (I used an average return rate of 8%, which is very reasonable for long term investments).

Actually I just ran it through a calculator, if a guy were to finance $200,000 for 30 years at 5%, there would be 1.5% taxes and .5% pmi, which would result in a monthly payment of $1281.98 and would pay interest of $176,011.57 (if you were in the 25% tax bracket you would get back $44,002.89 from the IRS which equals $132008.68 in interest) and $75,000 in taxes and $10500 in PMI. Because you would pay taxes on both ways of paying off the house I won't include it or insurance, but you still end up paying $142,058.68 extra then buying a house outright.
Now I'm not sure what investment method you would use for the 200k, but lets just say you invested the 200k in Mutual funds at the time of retirement the person would end up paying taxes on the the $2,012,531 you stated above, so around 500k would be required for taxes if you are in a 25% tax bracket around retirement. In this scenario you would be left with around 1.5 million. Then you would deduct the extra interest payments which would leave 1.36 million.

Scenario 2. The same guy buys the same house for $200,000, but he decides to buy it with cash, so he can invest the $1,074 each month. His investment account starts with $0 and he deposits $1,074 every month ($12,888 per year). Using the same 8% average annual return rate, after 30 years he would have $1,576,793, which is quite a bit less, compared with Scenario 1.

In this scenario the user would not pay PMI or interest, so all that leaves is taxes. For both of these I didn't include Insurance because it would be the same for both. I left taxes out in scenario #1 as I will in scenario #2 because it's a wash. So if you and your wife maxed out your Roth IRA's for 30 years, which is $833 per month you would have around 1.2 million and then if you took the remainder each month which is $448.98 and invested it additionally in Mutual Funds you would have $673,602.53, which would be taxed at retirement say at 25% also then you would pay $168400, which would leave $505202. Combine that with the Roth's and you would have over 1.7 million after taxes.

So the outcome I come up with is this.

House paid for 200k in cash = 1.7 million no taxes(less risky)
Invest 200k and pay mortgage for 30 years = 1.36 million after taxes and interest payments are deducted.(Much more risky, majority of foreclosures are those with mortgages)

Did you see my response to your math?

Nonetheless, I did some calcs and even assuming that PMI would be paid for the entire 30 years (which isn't true) the results are as follows:

Mortgage Holder
$200k invested at 8% compounded monthly for 30 years = $2,187,145.93 (basis of $200,000; LTCG of 1,987,145.93) = post tax value of $1,889,074.04

100% cash down {can invest the $1,073.64 mortgage payment and the $83.33/month of PMI)
$1,156.98/month invested for 30 years at 8% compounded monthly = $1,724,310.98 (basis of 416,511.57; LTCG of 1,307,799.41) = post tax value of 1,528,141.07

Even discounting the ability of the mortgage investor to invest the PMI premium once an 80% loan to value ratio is reached, the mortgage investor would still come out ahead by $360,932.98.


But the future is unknown. Investment returns could be 8%, but could be 4% (which cash house is better by $151,731) and could be 12% (where mortgage is better by $2.6 million).

It's all about risk tolerance.

Now I did the tax calculations using the current 15% max tax rate on long term cap gains, so I'll change it to match your 25% (which isn't how long term cap gains are presently taxed).

After 30 years -

Mortgage holder: $1,690,359.45 + paid for home
100% cash method: $1,397,361.13 + paid for home

Mortgage investor comes out ahead by $292,998 (roughly 1.5 times his original house purchase)

[dczech09]

JPG,

Using your numbers of $2,187,145.93 (1,889,074.04 post tax) for the mortgage investor; and $1,724,310.98 ($1,528,141.07 post tax) for the 100% down buyer. I ran the numbers myself and concur with your numbers.

You ignored the fact that the morgage investor has to pay for the house (plus interest of the loan). You must consider this otherwise your numbers do not accurately reflect the full cash outflow.

So ignoring the PMI and tax, your mortgage payment itself is $1,073.64 as has been discussed. That comes to a total outflow of $386,510.04 which translates to a total benefit of $1,502,564 for the mortgage holder; this is $25,577 less than the 100% guy (again, using your numbers).

So using a 5% interest rate on the mortgage, and an 8% return per year in the investments results in the 100% home buyer coming out better.

Now, the mortgage investor would have a tax deduction total of $44,002.89 which effectively increases their benefit to $1,546,566.53. This is $18,425.46 more than the 100% guy. You cannot tell me that the risk that the mortgage buyer took was worth a 1.2% overall spread.

When we ran the numbers earlier and used a 10% return on investment, the mortgage buyer came out further ahead (obviously) because there was a greater spread between the ROI and the cost of debt. As long as the spread is large enough, then yes, the mortgager will come out ahead.

I will not argue that the mortgager should come out ahead overall because they're taking more risk and thus deserve a "risk premium." However, we all know that the stock market is a random walk and may not work out as planned. Really, there could be a melt down during year 29 of our example.

As has just been illustrated, the mortgager is MUCH more vulnerable to the investment risk than the 100% down guy. The mortgage route is much more risky than the 100% down plan, which is what myself and littleroc have been saying. However much risk one is willing to take is their business.

[LivingAlmostLarge]

dcz, wait, though how do you calculate into the rent and years to accumulate the down payment? Let's factor in the 6 years to save the $200k the extra 6 years of investment savings and the 6 years of rent?

How does that affect the scenario? I know the numbers should also affect the decision correct because you can't compare $200k flat investment without some time of saving. And there is an inherent cost to saving $200k because you have to rent while you save right?

Wouldn't that make the spread larger?

Let's assume the rent for 6 years is $1150 and a 2% inflation increase. Does that change the numbers a lot?

Thank you for running the numbers for this lazy person. And how do you calculate you only have a mortgage deduction of $44k from $386K? What bracket are you putting the person in?

[jpg7n16]

So ignoring the PMI and tax, your mortgage payment itself is $1,073.64 as has been discussed. That comes to a total outflow of $386,510.04 which translates to a total benefit of $1,502,564 for the mortgage holder; this is $25,577 less than the 100% guy (again, using your numbers).

Why are you deducting the cashflow?

On day 1, 100% cash guy writes a check for $200k to the owner of the house. Mortgage guy takes out a mortgage, and writes a check for $200k to his investment account.

Each month, the mortgage investor would write a check for $1,156.97 to the bank, and the cash investor would write a check for $1,156.97 to the brokerage company.

The consequence to cashflow is identical.

So if you're going to deduct the cashflow from the mortgage investor, why not do the same for the 100% cash investor?

You don't have to compare the cashflow. You have to compare the ending net worth.

---------------------------------------------------------
Mortgage investor

Day 0: $200k in cash, $0k home, $0k mortgage, $0k investments
Day 1: $0k cash, $200k home, $200k mortgage, $200k investments
Income: $X, payment to mortgage $1,156.97/month, $x to taxes and insurance
30 Years later: $0k cash, $200+k home, $0k mortgage, $1,889,074 investments (after tax)

Cash investor

Day 0: $200k in cash, $0k home, $0k mortgage, $0k investments
Day 1: $0k cash, $200k home, $0k mortgage, $0k investments
Income: $X, payment to investments $1,156.97/month, $x to taxes and insurance
30 Years later: $0k cash, $200+k home, $0k mortgage, $1,528,141 investments (after tax)


The cashflow, home value, taxes and insurance all don't matter in the end - because they're all identical for each investor. In the end, the mortgage investor would be well ahead if investments average 8%.

[dczech09]

dcz, wait, though how do you calculate into the rent and years to accumulate the down payment? Let's factor in the 6 years to save the $200k the extra 6 years of investment savings and the 6 years of rent?

How does that affect the scenario? I know the numbers should also affect the decision correct because you can't compare $200k flat investment without some time of saving. And there is an inherent cost to saving $200k because you have to rent while you save right?

Wouldn't that make the spread larger?

Let's assume the rent for 6 years is $1150 and a 2% inflation increase. Does that change the numbers a lot?

Thank you for running the numbers for this lazy person. And how do you calculate you only have a mortgage deduction of $44k from $386K? What bracket are you putting the person in?

The person saving up $200k for the investment would also have to rent for your example of 6 years. The cash outflows would be the same; it is a wash. Also, the rent paid out to the point of both parties saving up the $200k would be a sunk cost and thus would factor into our calculations. Even if they did, both parties would be affected the same; the numbers will note change unless of course one rented in St.Louis, MO and the other rented in New York, NY.

As for the mortgage, that is assuming a 25% bracket. We came up with that number a while back.

[dczech09]

Why are you deducting the cashflow?

On day 1, 100% cash guy writes a check for $200k to the owner of the house. Mortgage guy takes out a mortgage, and writes a check for $200k to his investment account.

Each month, the mortgage investor would write a check for $1,156.97 to the bank, and the cash investor would write a check for $1,156.97 to the brokerage company.

The consequence to cashflow is identical.

So if you're going to deduct the cashflow from the mortgage investor, why not do the same for the 100% cash investor?

You don't have to compare the cashflow. You have to compare the ending net worth.

---------------------------------------------------------
Mortgage investor

Day 0: $200k in cash, $0k home, $0k mortgage, $0k investments
Day 1: $0k cash, $200k home, $200k mortgage, $200k investments
Income: $X, payment to mortgage $1,156.97/month, $x to taxes and insurance
30 Years later: $0k cash, $200+k home, $0k mortgage, $1,889,074 investments (after tax)

Cash investor

Day 0: $200k in cash, $0k home, $0k mortgage, $0k investments
Day 1: $0k cash, $200k home, $0k mortgage, $0k investments
Income: $X, payment to investments $1,156.97/month, $x to taxes and insurance
30 Years later: $0k cash, $200+k home, $0k mortgage, $1,528,141 investments (after tax)


The cashflow, home value, taxes and insurance all don't matter in the end - because they're all identical for each investor. In the end, the mortgage investor would be well ahead if investments average 8%.

Ok I follow you. I was looking at it from a cash flow standpoint and not a net worth standpoint as you are.

However the mortgager is paying the money to lower a liability while the buyer is increasing an asset. The cost of the debt needs to be taken into consideration as one party is paying out interest (essentially throwing money away) while the other is saving the interest.

Yes, the balance sheets for both are being affected the same way with the $1,156.97 payment per month. However the cost of debt represents the opportunity cost for the mortgager.

I think we're going around in circles here. How about we agree to disagree. Afterall the real answer is risk tolerence which is not something that can be mathematically quantified.

[jpg7n16]

However the mortgager is paying the money to lower a liability while the buyer is increasing an asset.

A similar argument can be made for the initial $200k. The cash buyer is using his $200k to avoid a liability, while the mortgager is using his $200k to acquire investment assets.

Except the mortgage investor is leveraging his initial position to acquire more assets

The cost of the debt needs to be taken into consideration as one party is paying out interest (essentially throwing money away) while the other is saving the interest.

The interest cost is already accounted for by the amount of cash it takes to remove the mortgage.

Without the interest costs, the mortgage investor would be able to invest additional funds each month.

Yes, the balance sheets for both are being affected the same way with the $1,156.97 payment per month. However the cost of debt represents the opportunity cost for the mortgager.

And the income from the investments is the opportunity cost for the cash buyer.

I think we're going around in circles here. How about we agree to disagree.

Fair enough

Afterall the real answer is risk tolerence which is not something that can be mathematically quantified.

The math is very simple. 8% > 5%. It's really that easy.

But it's a risky 8% versus a guaranteed 5%. That's why risk tolerance is the determining factor for if you should try this strategy.

[LivingAlmostLarge]

but isn't it really 3.75% if you assume a 25% tax bracket? Not 5%?

dcz, how much does it change if you only assume that both people have $50k saved and one buys, while the other rents for 6 years saving the $200k? Gotta say though saving $200k in 6 years without compounding interest is at least $30k/year which is hefty I think.

Especially since it probably should be saved in a money market or cash equivalent since it's so short term. Also that's after tax dollars so assuming that it's 25% of a families income they need to be making $120k/year gross minimum which is 2.5x the average family's income in the US right?

And I think it's like the top 5% of wage earners right? So it's not like it's normal to save that much?

[littleroc02us]

Oh you mean this post (quoted below) that was based on faulty math?

Nothing wrong with the math, I think you mean the strategy used.

1) Why did you only consider the Roth IRA for your preferred method, while ignoring this possibility for the mortgage holder? Can they not move $10k from their investments to their Roth each year? Why did you give 1 scenario tax free withdrawals and not the other?

Because I based my mathmatics off of Safari's post which stated and I qoute "A guy buys a house for $200,000 and finances the entire amount ($200,000) at 5% APR for 30 years fixed, even though he has $200,000 in cash, which he decides to invest into stocks and mutual funds. Every month he pays $1,074 to the bank and doesn't make any additional deposits to his investment account. In 30 years he would have the house paid in full and he would also have $2,012,531 in his investment account (I used an average return rate of 8%, which is very reasonable for long term investments)." Secondly the investment amount changes from 200k to 160k because any sensible man would have put 20% down which comes out to 40k.




2) Even though you say you won't consider the taxes, you still include them in the payment amount of $1,281.98. Your second scenario - you let the individual invest the amount for taxes and PMI. (833 + 448.98 = 1281.98)

You were using an old post, I changed the tax figures used because in the first calculation I messed up on the tax part and to qoute myself "I believe the only part I messed up on was using the tax info or not." Take a look at the second calculation sheet I did, it's correct.


The actual mortgage payment is only $1073.64. And 0.5% PMI is $1000/year ($83.33/month).

Wrong again, use a mortgage calculator and if you take out a mortgage for 160k @ 5% for 30years putting down 20% and 1.5% for taxes it comes out to $1025.58. You forgot to include the paying of interest and using the figure of 160k and not 200k because you would put 20% down to avoid PMI.


Although your words said you weren't accounting for taxes, your math says otherwise. Once you back out the Taxes from the equation (like I did in my calcuations posted earlier and quoted below) - you'll see that the mortgage investor comes out well ahead.

Nope, you were using an old post.




Now I did the tax calculations using the current 15% max tax rate on long term cap gains, so I'll change it to match your 25% (which isn't how long term cap gains are presently taxed).

After 30 years -

Mortgage holder: $1,690,359.45 + paid for home
100% cash method: $1,397,361.13 + paid for home

Mortgage investor comes out ahead by $292,998 (roughly 1.5 times his original house purchase)[/QUOTE]

That's not how my math came out look at the post I made a while ago with the tax changes from my original post.

Here's the post I did after I made the proper corrections:

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)