Wednesday, December 17, 2014

Viewer Mail - How Much for Down Payment On Home?

More viewer mail....

A reader writes:

I am thinking about buying a home in the next couple years and have been trying to figure out what makes sense to do so for a down payment and interest paid over the term of the mortgage.  Obviously the more you can put up front the better, but paying for a house in cash is a little out of reach for most people.

Secondly, I will be spending money on rent for the next 5+ years which is money that I will never see again. I am wondering where the tipping point for rent paid vs interest paid or if you have any advice for how I should go about thinking about this. Most blogs I've read recommend saving 20%, but still that's paying interest on a 15-30 year mortgage which still adds up to a ton of money. To me its a question of math. I'm just not sure what the equation is.

As I have noted before, I don't give advice here.  I just put forth my ideas, and if they work for you, great.  No warranty expressed or implied.  You have to make your own decisions in life.  I only suggest using a calculator rather than slogans or beliefs.

The traditional rules about home buying (pre-bubble) were this:

1. Don't buy a home unless you plan on living in it for FIVE YEARS.  That is the time it takes to break-even on the transaction costs of buying the house and selling it.  I detailed this in a posting.   The house may appreciate at 2% a year, and the transaction costs (at both ends) total about 10%.

2.  Put down 20% if possible, to avoid Mortgage insurance (PMI) and to avoid ending up "upside down" on a home.  My first house I bought in the bubble of 1989.   I put down 20%, and was never "upside down".  Others, who were not so lucky (or smart) did funny-money deals with little down, and ended up being stuck with houses, going bankrupt, or having to pay cash at closing when they sold.   Put as much down as you can afford, if you can't save up 20%.  Don't be suckered into low-money-down deals if you can - they usually have higher interest rates.

3.  Buy as much house as you NEED, not as much as you WANT.   If you are starting a family and plan on having two kids, a one-bedroom condo is not a smart choice.  But a six-bedroom mini-mansion with a four-car garage, that you can barely afford, is not a smart choice either.   The first choice means you will end up selling in short order (see #1 above) and the second choice means you will be house-poor and more likely to be upside-down (See #2 above).  If  a Real Estate agent tells you to "buy as much house as you can afford" then find a new agent.

4.  Avoid Condos - they swing wildly in price and are very expensive for what you get.  Also, if you are starting a family, you may outgrow them in a short period of time.  Condos may work in a few specific situations.  But read my blog posting on this, and when the bad shit happens, don't act surprised.

5. Do the math - if it is cheaper to rent, then may you should rent.   In today's market, there are bargains out there.   But just a few years ago, in places like Florida, people were paying four times as much per month to own, than to rent.  Pretty dumb, in retrospect.

I tend to think those "old school rules" are pretty smart.   During the 2000's people said they were "old hat" and we all saw what happened.

There is no fixed equation - it depends on you, your income, the market you are in, the price of the house, the finance rates, property taxes, etc.

I think in general the more you can put down the better.  Avoid that PMI, get the best interest rate you can (and rates today are staggeringly low - a good time to lock in on a good rate!).  But buy as much house as you need - in a decent neighborhood.  Location is key.

Granted, not everyone can put down 20%, particularly when buying that first home.  But the more you can put down, the lower your overall costs will be and the less chance of being "upside down" if housing prices tank.   And traditionally, that is why banks required large down payments in the past.

Buying more house than you need (but you think you can afford) is generally a bad move.  Giant houses cost a lot of money, cost a lot to heat, cool, and maintain, and the property taxes can be staggering.  A house is not an "investement" but a place to live - it is an expense, not a savings plan.  So ignore real estate agents who suggest becoming house poor.

I think if you are thinking about all of this rationally and hard, you will do well. 

Most folks walk into a "dream home" and say, "Ohhhhh!  Granite Countertops!  Where do I sign?"

And that, in short, explains the housing bubble of 2008.

With regard to down payment, we were fortunate that my partner had some money left to him by his Grandmother and his parents were willing to kick in some as well.  That, combined with our savings, put us over the 20% mark and we avoided PMI.   Some parents don't mind "helping out" a child with their first home, but it depends on how wealthy your parents are, etc.  Marks parents helped us out.  Mine said, "go fuck yourself."  That's OK, we did well anyway.

The only time I did a "nothing down" deal was on a $400,000 town house office in Old Town Alexandria, that I bought for $210,000.  I sold it two years ago for $680,000 - and the mortgage payments were paid for by tenants during the 10 years I owned it (and I took a $200,000 depreciation deduction on my taxes, for ten years as well).  Commercial Real Estate is a whole different deal than private homes.

Those were the days!  But that was an investment property, and your home is really not an investment per se, although you will do better than renting, if you stay there 5 years or more.  The longer you stay, the better off you will do.

Good Luck!