Monday, September 12, 2005

Down Payment: High or Low?

Here's a question. When I think about buying an apartment, my calculation of the costs usually factors in a downpayment of about 25%, sometimes closer to 30%. I have had $50,000 earmarked for a downpayment for several years. As for my other savings, as they've grown, I've figured out how much 6 months living expenses would be, and used that as a minimum cushion of savings to keep on hand, in some combination of stocks, bonds, and CDs/cash. I think I could free up as much as $75,000 for a downpayment.
Based on the down payment, I figure out if I can cover the monthly costs of the apartment out of my paycheck, given the rest of my monthly budgeted expenses. If I can't save at least $100 out of my paycheck each month, I consider the apartment a no-go.
But given that mortgage rates are still pretty low, am I making a mistake? Should I be borrowing more and keeping more of my cash in investments that have the potential to earn more interest than I would pay on the mortgage? And if that puts me in the red a little each month, just draw the money out of my savings? It does seem risky, since my mortgage costs wouldn't vary, but an investment with high potential returns could also lose value. And I'd have to keep a portion of my savings in low-earning accounts for them to be liquid enough to draw on for monthly bills.
The idea of spending more than my net pay in a month really bothers me, even if I'd end up ahead after a bonus and tax refund.
A bird in the hand is worth two in the bush... but is a dollar in the house worth two in the bank? (or something like that!)
[NOTE: Since I do have cash, I would never put less than 20% down. I would never pay PMI unless I really had no cash. The question is whether to voluntarily pay more than 20% in a building that doesn't require it, just to have a lower monthly mortgage payment. ]


Jose Anes said...

Interest rates are still low.
Put as much as you can until you can hit the 20% mark and avoid PMI.
That is what you should put for down payment.

You probably get a 6% mortgage, tax deductible. Pay it constantly, and you will do well over time (just don't take equity lines).

Use the cash to invest in something that gives you around 10% a year (average year) like the S&P 500.

The extra money will be there and will be available to pay the monthly payments if you loose your job.

However, if you do not have the money in some liquid assetts you would be forced to sell the house.

Money and investing

Anonymous said...

My friends that were looking in brooklyn found it easier to put 20% down at least, because coop boards really didn't take them seriously until they did. Their incomes were on the low side of what they needed to qualify. I hear in Brooklyn the standard downpayment is 10%. I'm at the point where I hate my mortgage, and I want to pay it down, beause it seems like such a burden.

Anonymous said...

I am thrown a little by your use of the word apartment. I would guess
this is a difference in language based on the part of the country.
Since you are talking about buying the place, I will just make my
comments based on that.

I think you are smart in saving enough for the down payment of 20%,
and enough to have your 6-month expenses available as an emergency
fund. My wife and I keep our emergency funds in more liquid assets.

In the decision to buy, I would look at the level of rent vs the
mortgage payment for your 30-year mortgage. If the difference is
significant, then I would continue renting and invest the difference
into stocks. This would replace the equity you would be getting in
the purchase of a home. Equities grow faster than real estate over
long periods of time, and eventually rents and property values will
come back together.

If you are buying the home/apartment, you want to be able to keep the
savings at an adequate level. A typical level of your budget toward
housing may help. I think that 35% may be the maximum. You may need
to save more toward a larger down-payment if the prices in your area
are much higher. I agree with you that you don't want to have the
negative cash flow situation.

In the decision of what amount to use to pay down the mortgage vs
investing in stocks and bonds, my wife and I like to divide any funds
available between our various objectives. Currently these objectives
are paying off our house, saving for retirement and saving for our
children's education. We invest equal parts to each, and put a
little more to our mortgage each month.