Personal Finance Blog by Debit versus Credit

Why A Large Down Payment Isn’t Always Best, Take Two.

December 11, 2008 | Filed in: Loans and Credit | 1 comment

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Yesterday I posted a blog entry about down payments when purchasing a home and why I found that paying extra down doesn’t necessarily save you much money over the life of the loan. Turns out that my findings were highly controversial. Before you do anything else make sure to read Does A Large Down Payment Save Money In The Long Run, and DO NOT forget to read the comments as well.

The whole point that I was trying to make is that it’s good to think outside of the box sometimes. Why use all of your cash for a larger down payment when you don’t have to, right? Also there are ways to save money on a mortgage by not paying extra down on the purchase of a home.

Controversy on Debit versus Credit

However like I mentioned earlier my previous post about paying less toward a down payment is the most controversial post that I’ve ever written, as evidenced by all of the negative comments toward it. I even had someone e-mail me demanding that I take the post down because it is misleading, especially when I claim to be fighting financial ignorance here at Debit versus Credit.

The funny thing is that they’re all right.

I’ll admit when I’m wrong. That post was slightly misleading, but I can assure you that those were not my intentions. I will not back that post off, however, because I still stand behind the point that I made in it. Let me explain.

Here’s the thing: when you take out a 30 year mortgage the mortgage firm will amortize the entire amount you borrow into a 30 year payment plan. So when you borrow less (because you paid more down) then your monthly payments are going to be lower. The amortization schedule above reflects that. This is where the majority of the complaints about my previous post came from. They said I wasn’t comparing apples to apples.

Why I Won’t Back Down

Maybe I wasn’t being fair in my comparison, but the way I look at it the average consumer is not going to care about anything other than their monthly payment and how much cash they are spending out of their own pockets. If they see a monthly payment that is only $7 a month less after paying an extra $7,500 cash out of their own pockets toward a larger down payment they are not very likely to want to pay that extra $7,500 cash.

In fact my guess is that they’d be more likely to prefer a lower down payment with the option of paying more to lower their interest costs and the time spent paying down their loan. The world of finance is all psychological and I fall into this category as well. I’d rather pay less of a down payment, keeping the cash for emergencies and applying it over time as extra principal payments. Obviously it’s not a completely fair comparison, but it makes sense why there might be some advantages to doing it this way.

Their Comments Did Make Sense, Mathematically

With that being said I’d like to point out that the previous commenters were right. If you paid the 10% down AND paid the same amount towards the loan as you would with the 5% down payment you would save a LOT more money. In fact you’d save about $30k over the life of the loan, as well as have it paid off 40 months earlier. That’s an awesome difference and something that is worth considering.

There Are Still Reasons To Pay Less Down

However if you have the cash to pay extra down but are worried about using all of your cash then don’t use it all. You can still save money. Just plop that cash in a high interest-bearing savings or money market account and pull a little bit out of it each month to through towards your mortgage payment. You’ll save money over the long run and you’ll still enjoy the peace of mind that comes from having a substantial cash pile.

Tags: Home Ownership, housing, saving

Does A Large Down Payment Save Money In The Long Run?

December 10, 2008 | Filed in: Personal Finance | 13 comments

I love spreadsheets.

I’ll be the first to admit that I’m a total spreadsheet nerd. My wife and I have been talking lately about buying a house sometime next year and that’s led me to do some number crunching in Excel, trying to figure out how much money we should put down on a house.

After some extensive crunching and comparing I’ve come across some interesting results, which to be perfectly honest with you I didn’t necessarily believe at first. Before I tell you what I learned though, I’d like to get your opinion on the matter.

Make sure you vote before continuing the rest of this post.

(more…)

Tags: Home Ownership, housing, saving

The Automatic Millionaire: Ch 6

July 11, 2008 | Filed in: Friday Book Club | No comment

Chapter 6 of The Automatic Millionaire is entitled Automatic Debt-Free Homeownership

David Beck stresses three principle goals in The Automatic Millionaire.  As we’ve previously covered the first two goals are to decide to pay yourself first 10 percent of your pretax (or gross) income and the second is to make it automatic.  The third principle goal which he stresses as very important to the ultimate goal of building wealth and financial independence is to buy a home and pay it off automatically.  As David says this chapter of The Automatic Millionaire is all about why you should own a home and “how you can pay for that home automatically so you can be debt-free before you’re too old to enjoy it.”

The fact is, you aren’t really in the game of building wealth until you own some real estate.

Mr. Bach is so passionate about his belief that owning your own home is most important to becoming financially independent that he even went so far as to say: “The fact is, you aren’t really in the game of building wealth until you own some real estate.”  I will be quick to point out that I have a problem with this statement of his, although I do agree with the idea that owning your own home can be beneficial to building wealth.  I’ll come back to this later.

Six Reasons Why Homes Make Great Investments

David brings up six reasons why he thinks that homes make great investments.  I’ll list them here for your reading pleasure.

1. Forced Savings
2. Leverage
3. OPM (Other People’s Money)
4. Tax Breaks
5. Pride of Ownership
6. Real Estate Has Proven to be a Great Investment

Some of these are easier understood than others.  I’ll briefly explain what he says about each of these reasons for homeownership.  Forced savings refers to the fact that (in a good market anyway) buying a home forces you to save in that as you pay down the principle balance of the loan you’ll gain equity in your home.  Leverage is the ability to use money that is not yours to your advantage.  Basically if you purchase a home for $100,000 but only put 10,000 down and then five years later your home is worth $150,000 dollars you’ve gained $50,000 off of only a $10,000 dollar initial investment.  OPM is essentially the same as Leverage in that it refers to using other people’s money to your financial advantage.  Tax Breaks are relatively obvious: the government allows you to write down interest and other related home ownership expenses from your taxes.  Pride of Ownership is not exactly fiscally related, but nonetheless a nice benefit of home ownership.  David’s final reason that Real Estate is a great investment is disputable by many especially during hard times such as those we’re currently experiencing.  However it should be said that I believe that over the long run it is at least a good investment, but not necessarily a great one.

I Can’t Afford To Buy A House

So many people have used this excuse that it has become old and tired.  If you can afford rent there is a decent chance that you might be able to afford a house as well.  I won’t go into the specifics here for the sake of space and time, but basically David makes the point that with mortgage rates so low owning a home doesn’t cost (usually) much more than typical rents in your city or town.  He tries to back this thought up with informational charts showing how much a typical mortgage would cost for a certain amount spent on a house.  He also makes the point that there are several government programs in place which help first-time home buyers in their quest to own their own home.  These programs range from informational to actually providing help with a down payment or closing costs.  In short?  Research before you decide that you can or can’t afford to buy a house.

Why This Logic is Partially Flawed

As I mentioned previously David said that “you aren’t really in the game of building wealth until you own some real estate.”  This logic is flawed.  I agree that owning real estate can build wealth, but the act of building wealth does not require the ownership of real estate.  If someone preferred to live in a luxury apartment, for example, over owning their own home there would be nothing to stop them from building wealth.  They could still save a good chunk of their income and wisely invested there would be no reason that they could not build even more wealth than someone who chose to own a home.  It’s all circumstancial and basically I think it’s wrong to assume that unless you own real estate you won’t really be building wealth.

The Rundown

Essentially the point that Mr. Bach is trying to make throughout this chapter is that with just a little bit of planning and hard work anyone can become a homeowner.  He also brings up that if you make it automatic and pay even 1 extra payment a year towards your mortgage that you can cut off somewhere between 5 - 10 years off a traditional 30 year fixed mortgage.  If done with a little bit of foresight and planning owning a home can allow you to be able to build more wealth than you normally might.

Tags: Friday Book Club, Home Ownership, Real Estate, Wealth Building