Saving for a first (but expensive) home

[MarieL]

HI folks - Thanks to all of your great advice 2+ years ago, my investments (and those of my fiance!) are in great shape and we're starting to consider our first home purchase in the next 2-4ish years. Figured it was time to come back and ask for another round of advice

We live in the Bay Area where the average price of a starter home is in the $1.1M -$1.3M range (if you can find one... but that's another topic) and rising. We're both in Tech and love the area so this is the world we're dealing with . We're hoping to have $350k-$400k for our down-payment to escape PMI, and another $50k or so in anticipation of having children in the 3-4 year time frame and me taking some time off.

We currently have $100K saved in various bonds (details below), and approximately $150K more in cash that we can invest now.

Current Allocations of $100K:
VCAIX Vanguard California Intermediate-Term Tax-Exempt Fund Investor Shares - 33%
VWITX Vanguard Intermediate-Term Tax-Exempt Fund Investor Shares - 50%
VMLTX Vanguard Limited-Term Tax-Exempt Fund Investor Shares - 17%
(each has an ER of .2%)

So my main question is, where to invest the existing $100k, the new $150k and the $150k that comes after it?
(FWIW: $150k-$200k over next 3-4 years is after all retirement contributions (below). Given current salaries / stock this is probably close to the limit of what extra we can save, but is achievable.)

Seems our options are:
-> Continue with the above bond funds, in some %. I started with those percentages when the house was more like 6 years away, so maybe it is too risky for a 2-3yr time horizon? I know there's also a lot of talk of a Bond Bubble, which I admit to being rather ignorant about...
-> Invest in some CDs - Ally looks to have some of the best rates at around 1.5% which aren't particularly exciting but obviously very low risk.
-> IBonds? As far as I can tell this would be only $10k (for both of us) per year - are these advisable? Either way would need to do something with the rest.
-> ??? Anything I'm missing?

Thanks for the help - have tried to read up on the rest of the posts similar, but curious on thoughts on our current situation. (Some more details below, if those are relevant). Any thoughts, advice, corrections, etc very much appreciated


Other Investment details (happy to provide more if it would be useful).
-----------------------
Emergency Fund: 9 months
Tax Brackets: 35% Federal, 10.3% state (CA)
Debt: 0
Filing Status: Currently single, but will be married in June so Married for 2014-filing year tax purposes.
Age: both 27

Hers
------------
401K - $150K (about 75% traditional, 25% roth via in-plan rollovers and some earlier Roth contributions)
Roth IRA - $25K
Taxable - $75K

His
-----------
401K - $130k
Roth IRA - $23k
Taxable - $55k

All invested in Vanguard standard funds (TSM, TBM, etc) with low ERs.
- Domestic equities: 58%
- International equities: 22%
- TBM: 15%
- REIT: 5%

Currently each contributing about $65K each to Retirement each year ($17.5K to 401k (+50% match), 5.5K Roth IRA (via conversion), about 8-10K to Roth 401K via after-tax contributions + in-plan roth conversations, and $25k each in contributions to Taxable account (this year will be about half of that though due to Wedding + honeymoon + Car purchase - all accounted for outside of these calcs)). Recognize this won't continue forever (hopefully kids + college, etc will come into the picture in a few years), but very thankful we can put this much in now.

If anyone has read this far, would be curious if you think we're over-saving (or if there is such a thing at this age!) and whether you'd allocate differently to long-term retirement vs shorter-term house, or even in-plan Roth 401k via after-tax vs taxable accounts.

Phew, that was a lot - thanks so much for reading!
--Marie

[Userdc]

You are doing an excellent job. I don't think many people on this forum will tell you that you are saving too much, and I'm no different - kids and a million dollar house can certainly impact that savings rate in the future. You also may be due for a tax wallop when you start to file jointly.

My general advice:

Seek out other tax shelters. Backdoor Roth. HSA. 529 (yourself as beneficiary for now). I bonds (no reason not to max out every year). EE bonds.

I'm not a huge fan of the muni investing in your taxable account. Even given your high tax bracket, I think you can replicate those after-tax returns with safer I-bonds and CDs. Don't let the desire to aboid taxes drive your investments, it's just a tool to get to the goal of maximizing total after-tax returns.

Also, even in the Bay Area, if you are spending $1.1 million, you should be able to get something more than a "starter home". Given the high transaction costs of real estate, don't settle for a house you can't see yourself in for at least 5-10 years.

[bottlecap]

Id just go with CDs. You're not looking for return, so low risk and little hassle fits the bill.

JT

[MarieL]

Thanks for the advice!

Re: Backdoor Roth - already have that one covered (that's how we have Roth IRAs). Will look at HSA next year (company just started offering it but missed open enrollment). Haven't considered a 529 before, but will look more into it. Guess it's never too early to start saving for college.. the main downside is that if the funds go unused, there's a 10% penalty on earnings in addition to normal tax rates, correct?

For more tax-advantaged space, the in-service rollover of after-tax contributions seems like the best deal though (assuming that we don't need the money until much later). Curious, any opinions on rolling into Roth 401K vs Roth IRA? The funds available in our Vanguard 401K are great (and are generally all Institutional rates, so even lower than our IRAs), so we've been rolling there.. My assumption is it all ends up in the Roth IRA at some point down the road so go with the better funds now?

Re: IBonds: They're only tax advantaged for later educational expenses, correct? Is their main value the index to inflation, that will change much faster than a long-term CD? (and I guess, they have a slightly higher rate right now than CDs too). Can you now purchase $10K per SSN online? (tax refund is non-existent this year, so that won't work for the paper bonds).

re: Munis: yeah, I went this route a few years back as returns were fairly high and I was concerned about tax implications. Seeing the actual returns though I'm slightly less worried - Will look at moving these to CDs and IBonds. Probably should have done this LAST year (to get it into my last Single filing year), but that's neither here nor there.. (re: taxes, yea, we're about to get slammed... Good problems to have I suppose)

In looking at CD rates, it seems Ally still has the best deal with only the 60 day penalty on early withdrawals.. CIT bank (which I've never heard of) seems to offer a slightly higher rate but a full 12 month penalty.

Thanks again guys -

[john94549]

Another option (for CDs) might be PenFed. I believe the 1.85% 3-yr has a 6-mo penalty.

Thought: if you're in the Valley, snoop around Sunnyvale, specifically the area around Ponderosa Park. The homes there date from the early 70s, but many have been up-dated and re-modeled. We bought our first home at 720 Sequoia. Drove by several years back, and it had been thoroughly gutted in preparation for a major re-do. Homes range from smallish 4 BRs to somewhat larger 5 BRs/split.

[Honobob]

We live in the Bay Area where the average price of a starter home is in the $1.1M -$1.3M range (if you can find one... but that's another topic) and rising. We're both in Tech and love the area so this is the world we're dealing with . We're hoping to have $350k-$400k for our down-payment to escape PMI,

We currently have $100K saved in various bonds (details below), and approximately $150K more in cash that we can invest now.


--Marie

Are you really waiting 2-4 years to purchase in a rising market JUST to avoid PMI? How much would PMI be? If rates went from 4% to 5% on a million dollar loan during that time you'd be paying $214,000 MORE in interest for the SAME property!

Bay area homes doubled in value in 1980's and again in the 1990's and again in the 2000's. That doubling usually occured in 24-36 months. Will that happen again in the 2010's? I think so. But which 24-36 months? If I were you I'd at least invest in a property NOW that you could put 20% down on so that you at least move up with the market instead of being priced out.

[MarieL]

Honobob: A fair enough point, I should have phrased that better. We'd like to have a large enough downpayment to escape PMI, but that's not the actual reason for waiting. It's more that we are likely to purchase in the suburbs of San Francisco (East Bay, South Bay, etc), and are not yet ready to make the move out of the city (we still have a few kid-free and carefree years left ).

We've casually looked at condos in the city to do exactly as you've mentioned, but even those are going for $1M+ . The extra $150K towards the down-payment is relatively recent (some recent stock sales), which could make this a more reasonable prospect. Going with the market is definitely something to consider. Thanks!

[retiredjg]

Curious, any opinions on rolling into Roth 401K vs Roth IRA? The funds available in our Vanguard 401K are great (and are generally all Institutional rates, so even lower than our IRAs), so we've been rolling there.. My assumption is it all ends up in the Roth IRA at some point down the road so go with the better funds now?

I don't have an opinion, but if you don't know already, look into the 5 year clock that attaches to the money in Roth 401k. I don't know anything about this other than I believe I read that one exists. This might make rolling after-tax money to Roth IRA more attractive for some of the money since that money would not have a 5 year clock (although I believe the earnings would). If you needed money, this could be a source.

You guys seem to be saving an incredible amount of money!

For your house money, I think I'd leave the old money invested as is, but start moving to a more conservative style for your new money - maybe using more of the shorter term bonds and also some CDs.

[epilnk]

I'm not one of those who worries about the "bond bubble" and I continue to hold both the int and long CA muni funds. However I do this because I don't expect to liquidate them soon - I would not use these funds if I needed them for a house downpayment in the next few years. Interest rate risk is real and probably significant right now - VCAIX was probably appropriate when the house was still 6 years off since the duration is only 5.5 years, but your horizon is now shorter than the duration of this fund. I assume you aren't going to put your life on hold if you don't like the interest rate environment, and there is a very good chance that bond funds will have a lower value at the time you are ready to buy than they do now. So go for something with more stable value.

[furwut]

If I were you I'd at least invest in a property NOW that you could put 20% down on so that you at least move up with the market instead of being priced out.

I'd be leery of buying property unless I knew I intended to stay at least 5 - 7 years. The transactional costs of selling are high and the real estate market can suddenly decline leaving you underwater on your mortgage and trapped. Also - down the road it will be less pressure buying your house without the worry of simultaneously having to sell your present place.

In 2005 I purchased a condo in a brand new building located in the center of a major US city. The units in the building were mostly comprised of 1 br condos. The pricing and the area made them very attractive to the young professional crowd. No doubt many of the buyers felt pressured to buy then because prices seemed to be ever rising and renting was never cheap.

Of course with the crash many of the buyers, young couples, got trapped. Rather than staying 3 or 4 years and then moving on to a house and starting a family they found themselves having to make less optimum choices. Some have stayed on and had their children - Mother Nature keeps her own schedule - hoping to eventually get out before the children are too old.

Others left anyway - either choosing bankruptcy or becoming unintended landlords. The city I live in has strong tenant laws and a near professional class of deadbeats who prey upon unsophisticated landlords. I've heard several heart wrenching tales of owners who rented units to people who never paid them a dime. Sometimes, to just get control of their property back, the landlords have had to PAY the deadbeats to voluntarily leave the property.

Sounds like you have a fine plan. My advice is to stay focused, liquid and flexible, and when you have found the perfect house you will be in position to move quickly which will make your offer on the house more attractive.

[Honobob]

If I were you I'd at least invest in a property NOW that you could put 20% down on so that you at least move up with the market instead of being priced out.

I'd be leery of buying property unless I knew I intended to stay at least 5 - 7 years.

In 2005 I purchased a condo in a brand new building located in the center of a major US city. [/quote]
I woud also agree that you should PLAN on holding property 5-7 years but the FACT is that San Francisco properties really are NOT comparable to another "major US city" and there is a real potential for values to double over the next couple of years just like it has happened for at least the last 4 decades.. Waiting for the market to get red hot and THEN throwing money at property is what got people into trouble. Buy low, sell high.

[furwut]

... but the FACT is that San Francisco properties really are NOT comparable to another "major US city" and there is a real potential for values to double over the next couple of years just like it has happened for at least the last 4 decades.. Waiting for the market to get red hot and THEN throwing money at property is what got people into trouble. Buy low, sell high.

Well I've heard that California has some trees called Redwoods that are mighty tall but even those trees don't grow to the sky. I wouldn't bet against the SF market so you may very well be right. But that is what we are talking about here isn't it? A bet or speculation with real risk and potential for reward.

Under the time horizon school of thought money intended to be used within the next 5 years should be in cash or its equivalent. At most very conservatively invested. Would one take a fifteen year olds college fund and buy a house instead telling her its okay - We'll be able to sell in 3 years and send you off to State U right on schedule?

[NorCalDad]

I woud also agree that you should PLAN on holding property 5-7 years but the FACT is that San Francisco properties really are NOT comparable to another "major US city" and there is a real potential for values to double over the next couple of years just like it has happened for at least the last 4 decades.. Waiting for the market to get red hot and THEN throwing money at property is what got people into trouble. Buy low, sell high.

The trick is figuring out when is "low" and when is "high," of course. If we could figure that out, we might not be on Bogleheads.

[Honobob]

I wouldn't bet against the SF market so you may very well be right. But that is what we are talking about here isn't it? A bet or speculation with real risk and potential for reward.

Under the time horizon school of thought money intended to be used within the next 5 years should be in cash or its equivalent. At most very conservatively invested. Would one take a fifteen year olds college fund and buy a house instead telling her its okay - We'll be able to sell in 3 years and send you off to State U right on schedule?

What do you perceive the risk to be buying NOW vs. 2-4 years from now? Lower rates/prices? If I had a 15 year old and knew I needed a SF property now or in the next 2-4 years I'd bet on the house any day. I still need the house. Have you seen the rate of tuition increases?

[john94549]

Honobob, I hadn't really thought about that "doubling in 10" phenomenon. Then I thought about the house we bought in Sunnyvale in 1973 ($43K) and sold in 1978 ($103K). Same year bought in Lafayette ($180K). Still in Lafayette, same house (a few upgrades). Had it appraised last year for a re-fi. Not quite the "double in 10", but we're in the middle of one of those price spurts you mentioned, so who knows.

I went back and "Zillowed" the house in Sunnyvale we sold for $103 in 1978. I know it was renovated, but Zillow doesn't, and just based on square footage and comps thinks it's pushing $900K. As with Lafayette, not quite your "double in 10", but close. However, if you go back to 1973, when we bought it (4 months after construction) for $43K, it has more than "doubled in 10" over the past 40 years.

[Watty]

We're both in Tech and love the area so this is the world we're dealing with ..................It's more that we are likely to purchase in the suburbs of San Francisco (East Bay, South Bay, etc), and are not yet ready to make the move out of the city (we still have a few kid-free and carefree years left ).

I would highly recommend that you rent in the area where you think you might end up buying in before you buy a house there.

The problem is that you might consider your current lifestyle to be worth paying the premium housing prices for but the areas you mentioned are much different than living in San Francisco.

In some of those areas you might have an hour commute on a good day and once you get home there may be few amenities that are near your house. Even on a weekend you will likely find that you do less because you will have to travel a long distance to get to the places you want go to.

If you rent for a while out in the “burbs” first then you may find that moving to a less expensive area where your $350K down payment will buy a much much better house for cash looks better.

It was years ago but I was living in Sunnyvale and decided to leave the Bay Area when I was ready to buy a house and it was one of the best decisions I ever made. There are lots of Tech jobs outside the bay area and you might even be able to transfer with your current employer if it is a large company.

[Honobob]

It was years ago but I was living in Sunnyvale and decided to leave the Bay Area when I was ready to buy a house and it was one of the best decisions I ever made. There are lots of Tech jobs outside the bay area and you might even be able to transfer with your current employer if it is a large company.

Financially? Seems like you missed out on at least $800,000 of appreciation and having a property tax bill of under a $1,000 a year.
Would you elaborate?

[chocolatemuffin]

Where do you work? If you don't mind to look further south (e.g. San Jose), there are more affordable housing options with very decent school districts (i.e. elementary school API > 900). If your job allows flexible hour (e.g. get to work by 10am, for example), which is common in the Bay Area, the traffic isn't really that bad.

[bmelikia]

If I were you I'd at least invest in a property NOW that you could put 20% down on so that you at least move up with the market instead of being priced out.

I think you guys are both in great financial shape - - - maybe you might look at trying to do something along the lines of what Honobob said. Are there any properties out there that are priced so you could put 20% down and it be somewhere you could live for the next 2-4 years and you'd be ok with it knowing your stay is only temporary?

I only say this because your market in the bay area there seems to be unique.

I'm personally looking to save for 3-4 more years myself before purchasing a home --but my intent is to pay cash and homes I like in my area are around 165k so I'm thinking worst case scenario for me would be that maybe they would be worth 185k-200k when I'm ready to buy.

[Watty]

It was years ago but I was living in Sunnyvale and decided to leave the Bay Area when I was ready to buy a house and it was one of the best decisions I ever made. There are lots of Tech jobs outside the bay area and you might even be able to transfer with your current employer if it is a large company.

Financially? Seems like you missed out on at least $800,000 of appreciation and having a property tax bill of under a $1,000 a year.
Would you elaborate?

Ok,

This was in the late 1980’s and for comparison just before I moved a friend of mine bought a house in Santa Clara on a street with unusual name that I remember so I just looked up that neighborhood on Zillow. I moved up to Portland Oregon and rented for a while then bought a house up there.

I was a single computer programmer so I was making good but not spectacular money and interest rates were high so I could have only afforded a house in the Bay Area similar to the one that my friend bought.

His house in Santa Clara; a two bedroom, one bath, about 900 square foot, one car carport, about 40 years old and still had the original kitchen and bathroom, it was on a tiny lot. It was in a not so great neighborhood. It cost $97,000 and on Zillow it looks like houses in that neighborhood have been selling for about $500K or less recently.

The house I bought in Portland Oregon; Three bedrooms, two baths, about 2,000 square feet, two car garage, about 15 years old, on a quarter acre lot that overlooked a wetlands pond. It was in a very good area that had very good schools. It was in basically good condition but needed some updating of things like the avocado green countertops. It cost $87,000. I moved about ten years ago but I just looked it up on Zillow and it looks like it would sell for about $280K today which sounds about right.

It is true that the Portland house has not appreciated as much but the use that I got out of the larger and better house more than made up for that. One of the other benefits of living in a less expensive area is that other than housing the general cost of living is less too since it costs less for businesses to operate and hire people.

I was able to find a job in Portland for the same salary that I was making in Sunnyvale so salary wise it was a lateral move. I’ve always been on the technical side and never wanted to get into management so being out of Silicon Valley did not seem to hold my career back much if any although I ended up working for businesses that use computers instead of computer companies like I did when I was in Silicon Valley. These businesses have been a lot more stable than the computer companies so that has worked out well too.

Portland is only a short drive from the beaches, mountains, or forest hiking trails so I found that that I actually did a lot more activities there than I ever did in the Bay Area so for me the quality of life was a LOT better and I usually had less than a 20 minute commute to work. It was also a much better place to raise a family.