Roth IRA as a source of cash for a home down payment?

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Taylor Larimore
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Roth IRA as a source of cash for a home down payment?

Post by Taylor Larimore » Fri Feb 01, 2008 8:51 pm

Hi Bogleheads:

We frequently see posts from young investors with their first job asking where they should invest their money for a first time home purchase at an unknown time in the future (let's say 3-6 years).

Question: Is a Roth IRA a good choice for a home down payment?

Roth Facts:

* Roth's are generally limited to $5,000 ($10,000 per couple) per year.

* Contributions are not deductible

* Contributions can be withdrawn at any time without penalty or tax.

* After 5 years, Up to $10,000 of earnings can be withdrawn without penalty or tax for a qualified first-time home buyer or for qualified educational expenses ("qualified" means the IRS has certain criteria to avoid abuses).

* Withdrawals cannot be returned to the Roth.

I would appreciate your thoughts.

Thank you and best wishes.
Taylor

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Post by baw703916 » Fri Feb 01, 2008 9:16 pm

Hi Taylor,

Off the top of my head, I would say that the last point (withdrawals can't be returned to the Roth) would make this very undesirable.

In the TSP, you can borrow against your account to buy a house (you pay back your account at the rate of the G fund at the time you took out the loan). There's many good arguments against borrowing from one's retirement account under any circumstances. But if one is really set on doing this, I'd say it's better to at least borrow from somewhere to which you can return the money. I'm not sure if 401k's also have this feature, or if it's unique to the TSP.

Best wishes,
Brad
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Post by diasurfer » Fri Feb 01, 2008 9:41 pm

Gosh I don't know. I thought you could return Roth contributions. That's a bad one. Still, I might end up doing it someday if the deal seems right.

The problem I have with any rules of thumb concerning home purchase is how dependent it is on time and location. In 2004, I went with the rules of thumb that said don't buy a house if don't know you'll be in it for at least 3 years, don't buy if you can't put 20% down, don't buy if it means raiding your (tiny) retirement fund. Heck with my good credit and job I literally could have put $5K down and bought a $450K house.

3 years later I'm still in the same place, and missed out on at least $250K in home equity. Still renting and will be for years now - no choice - unless I leave here. :cry: But at least my retirement is in good shape!

My point is that rules of thumb concerning home purchases are a bad thing. You must consider the state of your local RE market.

Edit (after realizing my rant wasn't responding to your question):
FWIW, I save for intermediate term goals (such as buying my first house) with a 50/25/25 mix of PrimeMM/TSM/TSMint in a taxable account. Now I'm willing to take risk.
Last edited by diasurfer on Fri Feb 01, 2008 9:46 pm, edited 1 time in total.

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Post by Dale_G » Fri Feb 01, 2008 9:45 pm

In certain circumstances, it seems like a no brainer to me.

Jack & Jill want to buy a home in 5 years. They can save $5,000 a year, but not more.

They can save the $5,000 in a taxable account - or they can save it in a Roth IRA.

If they save it in a taxable account they will pay taxes along the way - and pay taxes on any capital gains when they access the funds. If it is saved in a Roth, they can withdraw all of their contributions + any earnings up to $10,000 tax free.

In this case, it does not matter than the funds cannot be returned to the Roth. The savings was intended to be used for the home purchase, not for retirement.

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Post by Spirit Rider » Fri Feb 01, 2008 10:27 pm

This is why I think that young people starting out should maximize their Roth IRA contributions "before" an emergency fund.

The Roth effectively becomes the location of the "emergency fund". It is true that you can not return the funds to the Roth. However, they would never have been there if you didn't contribute them in the first place.

Now obviously this assumes the discipline to resist any urge to use this money for frivolously. So I am an even bigger proponent to use for a house down payment.

This assumes some narrow parameters. That they don't have the means to both fund the Roth "and" a separate home down payment account. I really believe that funds shouldn't be taken out of a Roth account unless they wouldn't have been there except as a substitute location for this purpose,

I am concerned about people using this method to only save the Roth IRA limits when they could be saving more and thus effectively decreasing their retirement saving potential.

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Post by Spirit Rider » Fri Feb 01, 2008 10:41 pm

One other point.

Even though this money is in a "retirement account", it should be be considered in isolation to your overall assest allocation. It's allocation should tailored to the time frame of of it's intended use.

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Post by DickBenson » Sat Feb 02, 2008 3:31 am

Another factor that one can consider is that, like a Roth, the appreciation on a house is also tax free (up to 500K for a couple).

Dick

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Post by curiousinvestor » Mon Feb 04, 2008 11:16 pm

IMHO, there's a big consideration for young investors:

- Do you really know you want to buy a house in 3-6 years? Are you certain you'll be at the same job at the same location you are right now? Most people who buy a place need to feel somewhat comfortable with this question.

One is more certain that they'll eventually retire one day, so passing up on Roth contributions makes you lose out on significant compounding.

But I am not a home owner, so I have limited knowledge. I just know that if I bought a house years ago (I'm in my early investing years), I would feel tied down in a time where career/location/family are very uncertain. My retirement is certain. I can wait a few years longer, save more, earn a higher income, and get a house later on.

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Post by serbeer » Tue Feb 05, 2008 3:33 am

I think Dale really nailed it: Roth is superior saving vehicle, so why not use it regardless of the goal.

With 3-6 years horizon Taylor built into this puzzle, and Roth contribution limits (that mean you can invest no more than ~$50K), there cannot be so much interest growth that not being able to get to it would make Roth a bad saving vehicle for a house down payment.

Now, if we are talking about Roth 401K, where limits are 3 times as much, so interest during lucky years could top $10K, the answer could be different, but the question was about Roth IRAs, wasn't it.

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Post by Levett » Tue Feb 05, 2008 7:22 am

Hi Taylor,

All I can say is that one of my sons withdrew his contributions to a Roth for a down payment on his first home, and I matched his contribution so that he had a downpayment that helped him avoid PMI.

The appreciation on his home investment has grown nicely, and the remaining earnings in the Roth have been left to do their long-term thing. Of course, there have been tax benefits as well to his owning a home, and avoiding PMI frees up cash.

I think he feels, as his father does, that he got the best of several worlds! Bob U.

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Post by turboLT » Tue Feb 05, 2008 9:27 am

Spirit Rider wrote:
Even though this money is in a "retirement account", it should be be considered in isolation to your overall assest allocation. It's allocation should tailored to the time frame of of it's intended use.
I disagree. When you retire, you'll presumably spend money from all of your accounts, not just your ROTH. I used to manage separately and all I ended up with was a very tax inefficient brokerage account and an underperforming overall portfolio.

My goal, and the goal of most young people, is to build overall wealth. Any tax benefits are just a plus and a means to an end, regardless of Uncle Sam's intended purpose.

On the other hand, there is the cliche that you can't borrow for retirement...

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Post by user » Tue Feb 05, 2008 9:47 am

If you need to raid your retirement funds to buy a house, then you cant afford to buy a house. It's that simple. Same goes for not fully funding your retirement plans to save up for a house payment.

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Post by White Coat Investor » Tue Feb 05, 2008 9:53 am

user wrote: Same goes for not fully funding your retirement plans to save up for a house payment.
That's nonsense. If someone makes $50K and has access to two Roth IRA contributions and a 401K you are suggesting they have to be able to save up a house payment above and beyond the $25.5K they can put in retirement accounts? That's crazy. Many Americans have to either slow down retirement contributions or stop them all together to save up a downpayment. These same people are the ones for whom raiding a Roth IRA for a downpayment can make sense. If you can't max the thing out anyway, and don't expect you will ever need a taxable investing account, what's wrong with saving up your downpayment in it? It is a whole lot better than renting the same house for 30 or 40 years straight and still not owning a house when you hit retirement age.

Now for those of us who can max out our retirement accounts, or who invest in a taxable account, or will soon not have access to a Roth IRA due to income limitations, I think it would be a colossal mistake to raid a Roth IRA for a downpayment (or anything else.)
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Post by user » Tue Feb 05, 2008 10:09 am

EmergDoc wrote:
user wrote: Same goes for not fully funding your retirement plans to save up for a house payment.
That's nonsense. If someone makes $50K and has access to two Roth IRA contributions and a 401K you are suggesting they have to be able to save up a house payment above and beyond the $25.5K they can put in retirement accounts? That's crazy. Many Americans have to either slow down retirement contributions or stop them all together to save up a downpayment. These same people are the ones for whom raiding a Roth IRA for a downpayment can make sense. If you can't max the thing out anyway, and don't expect you will ever need a taxable investing account, what's wrong with saving up your downpayment in it? It is a whole lot better than renting the same house for 30 or 40 years straight and still not owning a house when you hit retirement age.

Now for those of us who can max out our retirement accounts, or who invest in a taxable account, or will soon not have access to a Roth IRA due to income limitations, I think it would be a colossal mistake to raid a Roth IRA for a downpayment (or anything else.)
Financially you will come out ahead renting for 30 or 40 years and putting the money you save in your tax sheltered account. I really dont understand the obsession Americans have with owning a home, maybe it is why so many of them have to work into their 70s.

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Post by White Coat Investor » Tue Feb 05, 2008 10:16 am

user wrote: Financially you will come out ahead renting for 30 or 40 years and putting the money you save in your tax sheltered account. I really dont understand the obsession Americans have with owning a home, maybe it is why so many of them have to work into their 70s.
I think that is unlikely if you also count in the value of the home after the mortgage is paid off AND if you count in the value of not paying rent throughout retirement. Can you run some numbers to support this argument?
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Post by user » Tue Feb 05, 2008 10:43 am

EmergDoc wrote:
user wrote: Financially you will come out ahead renting for 30 or 40 years and putting the money you save in your tax sheltered account. I really dont understand the obsession Americans have with owning a home, maybe it is why so many of them have to work into their 70s.
I think that is unlikely if you also count in the value of the home after the mortgage is paid off AND if you count in the value of not paying rent throughout retirement. Can you run some numbers to support this argument?
Sure. I feel like I have derailed this thread though, sorry OP :oops:

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Using a Roth IRA for home purchase?

Post by Taylor Larimore » Tue Feb 05, 2008 11:12 am

Hi Bogleheads:

I want to express my thanks to each of you who shared your thoughts on whether or not it is advisable to use a Roth IRA to save for a home down payment.

This is a concept I have not seen in any publication. It deserves more consideration.

Thank you and best wishes.
Taylor

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Post by Opponent Process » Tue Feb 05, 2008 11:29 am

EmergDoc wrote:
user wrote: Same goes for not fully funding your retirement plans to save up for a house payment.
That's nonsense. If someone makes $50K and has access to two Roth IRA contributions and a 401K you are suggesting they have to be able to save up a house payment above and beyond the $25.5K they can put in retirement accounts? That's crazy. Many Americans have to either slow down retirement contributions or stop them all together to save up a downpayment. These same people are the ones for whom raiding a Roth IRA for a downpayment can make sense. If you can't max the thing out anyway, and don't expect you will ever need a taxable investing account, what's wrong with saving up your downpayment in it? It is a whole lot better than renting the same house for 30 or 40 years straight and still not owning a house when you hit retirement age.

Now for those of us who can max out our retirement accounts, or who invest in a taxable account, or will soon not have access to a Roth IRA due to income limitations, I think it would be a colossal mistake to raid a Roth IRA for a downpayment (or anything else.)

EmergDoc, thanks for sticking up for us little guys (in California of all places!) who sometimes get forgotten on this board.

Yes, us middle-class families making less than $100K do our very best to max out our Roths every year.

When the Roth maximum was $2K, we could "afford the luxury" of taxable investing, but now we are forced to invest almost everything in tax-sheltered vehicles. :cry:

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Post by grberry » Tue Feb 05, 2008 12:58 pm

The average young couple or family has relatively low disposable income for multiple reasons.

One, it is early in their careers, so their current income is relatively low.
Two, they are very likely to be paying off college debt.
Three, they are likely to be paying off credit card debt.
Four, they are very unlikely to already have significant amounts of prior investments generating passive income, or significant passive from any other sources.

With all of this, what they should do is create their family financial goals and then a budget. After they have a budget, they will know how much they can save and invest currently. Only after they have done that will it be time to choose where to save and invest.

As the amount is likely to be low, it is very unlikely that they will be able to fully fund their potential retirement savings. At that point, they may be choosing what to save for. That Roth IRA contributions, and after 5 years an amount of earnings, can be withdrawn for house purposes is a pure benefit. It allows them, for little to no opportunity cost, to postpone the decision about the purpose of their savings while also saving in a tax advantaged fashion.

Since life can change a great deal in a few years, especially for 20 somethings, saving while deferring the usage decision is wise. Moving, changing careers, getting married, getting divorced, unemployment are all events that can and do occur to this age group with great regularity. My church has a median age in the mid 20s, and a turnover rate of roughly 25% a year (mostly due to movement away from the city). Temporary unemployment is not unusual, marriages are not unusual. We haven't had a divorce yet, but sooner or later I'm sure that we will. We've had people join and leave the military, and probably had other equivalent career changes that I don't know of. All these events change the financial picture significantly, making flexibility valuable.

The risk is that the restrictions on withdrawal (no earnings before five years and a maximum amount thereafter) will prevent a home purchase either when needed or when it would be advantageous. I consider this a minimal risk - but it does exist.

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Post by NYCPete » Tue Feb 05, 2008 12:58 pm

First off, I agree with User that if you have to significantly raid your retirement account, then you may not be in the market for a house. So I guess I don't agree with the premise of 3-6 years for an early 20 something to immediately save up to buy a house. IMO, if you want to do it right, you take longer. Here's an illustration of my thinking

******************

2 Examples:

22 year old A maxes out her Roth IRA for 5 years, until she's 27. Then ceases her Roth IRA contributions and saves the same $5000 every year for 5 years. She now has $25,000 + probable interest to put as a downpayment for a house, buy a house with her taxable savings, and then continue her Roth contributions thereafter (or until income dictates she can't) for the rest of her life.

22 year old B saves $5000 a year in a taxable account for 5 years, then at 27 buys a house with the $25,000 (+interest) downpayment. The she proceeds to put $5000 toward a Roth IRA every year thereafter (or until income dictates she can't) for the rest of her life.

************

From a long term financial perspective, which do people think is the better way to go? In my opinion, hands down it's option A, because they get tax free compounding working for them sooner. Again, IMO, the tax benefits of saving a little bit of taxes for 3-6 years in your 20's by using a Roth IRA to save for a house, is WAAAAY less important than what we all know lots of years of compounding can do for an investor in the long run toward retirement.

Go for the extra compounding. You'll never get those years back. If one insists on being in a house first, then one will be compensated with reduced compounding later in life. In my mind, it's not even a debate.

Full disclosure, I'm 27.

Best,
Peter


Technical note: In my example, I assume that since option A is going to use their Roth in 5 years, that they have it in Prime Money Market or short term bonds.
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Post by Buckeye » Tue Feb 05, 2008 1:26 pm

If my goal was to buy a home, I'd first contribute to my retirement funds just enough to get any matching. Then I would divert all additional savings to reach such a downpayment that would allow me to avoid any mortgage insurance. I'd then buy the house and then start to add to my retirement savings beyond the match.

Extra years of paying rent and living next to a noisy neighbor wouldn't appeal to me just to start a Roth early.

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Post by White Coat Investor » Tue Feb 05, 2008 2:31 pm

All right, let's put this idea that raiding a Roth IRA for a downpayment is always a bad idea to rest. Here's the assumptions:

A 30 year old investor has $25K in a Roth IRA that he can take out with no penalty and put toward a house which costs $125K or he can rent for $1000/month (increases 3%/year) The value of the home also increases 3%/year. We will assume a mortgage rate of 5.5% fixed for 30 years, and add a fudge factor of ~$150/month for taxes bringing us to $700/month mortgage. The Roth IRA grows at 8%.

Option A: Rent until age 65, then buy a comparable house.

Option B: Raid the roth, buy a house now and pay it off over 30 years. Investing the savings at 0% (he put it under the mattress, what can I say.)

Under option A, at age 65 that $25K is worth $370K. The house now costs $352K for a profit of $18K. He spent a total of $726K on rent.

Under option B, at age 65 the investor has been able to amass a savings of $474K (money he didn't spend on ever-increasing rent) in addition to a paid off house.

Looks like raiding the Roth was a pretty good idea for this guy. Imagine how much further he would have come out ahead had he actually gotten a decent return on his savings. A house is the best investment for many of our nation's middle class investors not because homes appreciate particularly fast, but because the savings of not paying rent grows exponentially.

This is obviously a rough example, but I think the displayed benefit is so big that the point has been made. Renting is a losing strategy if you're going to be staying in the same place. Getting into a home can be worth sacrificing even the holy grail of investment accounts, the Roth IRA.
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Post by Spirit Rider » Tue Feb 05, 2008 3:13 pm

turboLT wrote:
Spirit Rider wrote:
Even though this money is in a "retirement account", it should be be considered in isolation to your overall assest allocation. It's allocation should tailored to the time frame of of it's intended use.
I disagree. When you retire, you'll presumably spend money from all of your accounts, not just your ROTH. I used to manage separately and all I ended up with was a very tax inefficient brokerage account and an underperforming overall portfolio.

My goal, and the goal of most young people, is to build overall wealth. Any tax benefits are just a plus and a means to an end, regardless of Uncle Sam's intended purpose.

On the other hand, there is the cliche that you can't borrow for retirement...
I understand your point. Certainly your long term funds should have a universal allocation across all accounts (tax free, tax deferred, and taxable).

However, most people believe in keeping your special purpose funds out of your overall asset allocation. Such as emergency funds, house purchase funds, car purchase funds, children's college funds. This is because these funds have greatly different access time frames. Therefore, should have different asset allocations.

When you are well established and have sufficent funds for a variety purposes, you can probably relax this restriction. This is because you can somewhat self-insure against various probabilities. For example, I have to drain my car purchase fund for medical expenses. I can either deferr my car purchase or finance the car purchase. You also have more access to various credit funding sources (home equity, margin, or unsecured).

However, when starting out you have limited resources. So multipurpose funds in a Roth IRA, should NOT be part of a global asset allocation.

Finally, the cliche that you can't borrow for retirement does not apply. If you do extract funds that would never have been able to be in the Roth in the first place except for this strategy, you are not diminishing your retirement funds in any way.

This is really the key point. We are NOT talking about removing retirement funds. We are talking about funds that would not "otherwise" be placed there in the first place.

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Post by NYCPete » Tue Feb 05, 2008 4:32 pm

EmergDoc wrote:All right, let's put this idea that raiding a Roth IRA for a downpayment is always a bad idea to rest. Here's the assumptions:

A 30 year old investor has $25K in a Roth IRA that he can take out with no penalty and put toward a house which costs $125K or he can rent for $1000/month (increases 3%/year) The value of the home also increases 3%/year. We will assume a mortgage rate of 5.5% fixed for 30 years, and add a fudge factor of ~$150/month for taxes bringing us to $700/month mortgage. The Roth IRA grows at 8%.

Option A: Rent until age 65, then buy a comparable house.

Option B: Raid the roth, buy a house now and pay it off over 30 years. Investing the savings at 0% (he put it under the mattress, what can I say.)

Under option A, at age 65 that $25K is worth $370K. The house now costs $352K for a profit of $18K. He spent a total of $726K on rent.

Under option B, at age 65 the investor has been able to amass a savings of $474K (money he didn't spend on ever-increasing rent) in addition to a paid off house.

Looks like raiding the Roth was a pretty good idea for this guy. Imagine how much further he would have come out ahead had he actually gotten a decent return on his savings. A house is the best investment for many of our nation's middle class investors not because homes appreciate particularly fast, but because the savings of not paying rent grows exponentially.

This is obviously a rough example, but I think the displayed benefit is so big that the point has been made. Renting is a losing strategy if you're going to be staying in the same place. Getting into a home can be worth sacrificing even the holy grail of investment accounts, the Roth IRA.
With all due respect, Emergdoc, the issue is not whether renting or buying is better financially. The issue is how best to save for a house (using the Roth or not). There are enormous opportunity costs associated with not funding a retirement account early in your working life, just as there are opportunity costs with deciding to rent until one is 65 (though that is an extreme, somewhat unrealistic example IMO).

Given the basic context Taylor gave in the original post, regarding younger investors just getting on their feet financially, I'm still not convinced that a 22 year old should even be considering a house fund if they have an income limited enough that they can't put something away in a retirement account AND fund something in a house fund. Let me bring up compounding again: 5 extra years of compounded returns in your early 20s can mean hundreds of thousands of extra dollars at retirement than if you start later. A house is important, and I agree with you whole heartedly that everyone should try to own their own home, but doing it right away poses a serious opportunity cost.

I'm sure we could all find hypothetical examples to support our views, so maybe the true answer is, as with many things on this forum...

It depends.

Best,
Peter
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Post by White Coat Investor » Tue Feb 05, 2008 7:23 pm

It definitely depends, no doubt about it. 5 years of compounding matters a lot, but it isn't the compounding in your early twenties on a few thousand bucks that matters. It is the last 5 years before retirement when you have a large sum at stake that it matters most.

I see nothing wrong with people saving for a house downpayment prior to saving for retirement so long as they don't pass up a match to do so. Some people don't value retirement all that much but do value the security of owning their own home. If someone is willing to work to age 65 or 70 there is absolutely nothing wrong with starting to save for retirement at 30 or 35 instead of 25. They can use that money to buy a house, buy a boat, or splurge on trips to Europe, whatever their priorities may be. 30 or 35 years is plenty to save for retirement.
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Rent vs. buy

Post by Dan Kohn » Tue Feb 05, 2008 9:23 pm

EmergDoc, I think your rent vs. own calculation is misleading because a $125 K house rents for far less than $1000. $500 is probably more accurate.

Here is my favorite calculator (be sure to adjust the investment opportunity cost under General Settings up from 5.5%). In my analysis, most people do not stay in their homes long enough for them to be a good investment compared to the opportunity cost of renting and investing. If you get enough psychic benefit from home ownership to compensate, that's fine. But home ownership is also an extremely illiquid, un-diversified investment with many unknown and unexpected costs.

http://www.nytimes.com/2007/04/10/busin ... APHIC.html

Finally, here's a devastating image about just how far the rent to own ratio is out of whack after the house buying insanity of the last 10 years.

Image

That's from: http://krugman.blogs.nytimes.com/2008/0 ... kish-post/

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Re: Rent vs. buy

Post by user » Tue Feb 05, 2008 10:48 pm

howdy wrote:EmergDoc, I think your rent vs. own calculation is misleading because a $125 K house rents for far less than $1000. $500 is probably more accurate.
He also leaves out the fact that property taxes rise along with the value of the house, that on average a person is going to spend about 1% of the value of the home per year on upkeep, and that the mortgage payment on a house is going to be higher than the equivalent rent for many years so there are no "savings" with option B until many years down the road.

Not to mention that the avg mortgage is something like 7 years in this country before a refinance, home sale, etc.

What I have seen among my peers that choose to wait in funding their retirement until after they buy a house, is that they underestimate the true costs of owning a home. So they end up with a house and are still unable to contribute to their 401ks or IRAs.

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Post by dgrdfd » Tue Feb 05, 2008 11:58 pm

EmergDoc wrote:All right, let's put this idea that raiding a Roth IRA for a downpayment is always a bad idea to rest. Here's the assumptions:

A 30 year old investor has $25K in a Roth IRA that he can take out with no penalty and put toward a house which costs $125K or he can rent for $1000/month (increases 3%/year) The value of the home also increases 3%/year. We will assume a mortgage rate of 5.5% fixed for 30 years, and add a fudge factor of ~$150/month for taxes bringing us to $700/month mortgage. The Roth IRA grows at 8%.

Option A: Rent until age 65, then buy a comparable house.

Option B: Raid the roth, buy a house now and pay it off over 30 years. Investing the savings at 0% (he put it under the mattress, what can I say.)

Under option A, at age 65 that $25K is worth $370K. The house now costs $352K for a profit of $18K. He spent a total of $726K on rent.

Under option B, at age 65 the investor has been able to amass a savings of $474K (money he didn't spend on ever-increasing rent) in addition to a paid off house.

Looks like raiding the Roth was a pretty good idea for this guy. Imagine how much further he would have come out ahead had he actually gotten a decent return on his savings. A house is the best investment for many of our nation's middle class investors not because homes appreciate particularly fast, but because the savings of not paying rent grows exponentially.

This is obviously a rough example, but I think the displayed benefit is so big that the point has been made. Renting is a losing strategy if you're going to be staying in the same place. Getting into a home can be worth sacrificing even the holy grail of investment accounts, the Roth IRA.
I still don't buy it. I have done these calculations ad nauseum and I find it difficult to work out, from a strictly financial perspective, how home ownership is better than renting. Your calculations are biased because I know of nowhere you can buy a house for $300 LESS per month than you could rent the same equivalent home.

I have come up with a spreadsheet that illustrates all of this in a more balanced light. Here are my assumptions:

Home Buying
Home Price---------$125,000.00
Mortgage Interest--------5.50%
Property Tax--------0.5%
Maintenance-------1.50%
Home Appreciation------5.00%
Monthly Payment-----$709.74

Renting
Rent Per Month------$500.00
Rent Yearly Increase----3.00%
Investment Rate-----8.00%

I used a 25% tax bracket so you reduce the interest paid. I technically even gave the advantage to the house here because I effectively reduced the property tax and maintenance fees by 25% every year in lieu of computing the interest paid in a given year and taking anything over $5,000 and reducing it by 25%. You would only get to claim the mortgage interest without itemizing tax returns for about the first 10 anyway whereas I reduce property tax and maintenance fees by 25% every year.

So after computing all of this after 30 years saving your would be home payment - rent payment and investing would still put you at $30,000 ahead. And this is really stacking the odds in favor of the home:

1. I assumed a 8% return on investments when we all know that for long holding periods this is typically 10% when invested in equities
2. 5% home appreciation is above historic home averages
3. Unless you sell you home yourself you have ~6% commission to pay on the sell of your home

I am not trying to be argumentative in any way. I am just trying to learn. Am I missing something?

Here's my spreadsheet for anyone interested:

http://rapidshare.com/files/89535087/Re ... y.xls.html

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White Coat Investor
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Post by White Coat Investor » Wed Feb 06, 2008 11:38 am

dgrdfd wrote:
I still don't buy it. I have done these calculations ad nauseum and I find it difficult to work out, from a strictly financial perspective, how home ownership is better than renting. Your calculations are biased because I know of nowhere you can buy a house for $300 LESS per month than you could rent the same equivalent home.
I used my own mortgage for the comparison. My next door neighbor rents for $300 more than my mortgage. At any rate, the fact is within a few years the comparable rent will be more than the mortgage, so this point means little when the difference is so great. Start with the mortgage being $300 more a month and you'll end up with similar results.

The main difference between your example and mine is I neglected maintenance costs (not sure if 1.5% of the current value of the house is the correct amount or not), I didn't count in the gradually increasing property taxes, and I started with mortgage costing less than rent (uncommon in some markets, but not all, especially with low interest rates). Even so, after 30 years the homeowner is still $80K ahead and has no more mortgage payments to make. I think a renter also pays some maintenance costs in my experience....lawn mower, landscaping supplies, carpet cleaning, minor repairs etc,but I have no idea what % to assign to that. Granted they won't have to replace appliances, a roof, carpet, or a major paint job, but the number certainly isn't $0. I guess I just don't buy your argument that ownership NEVER becomes less expensive than renting. Does anyone out there who has owned their home for 25 years really feel they spend more on their home each year than it would cost to rent a comparable place?

Also, I think most individual investors get less than an 8% return, present company excluded.

BTW, it would strengthen your argument if you started with $25K in the Roth IRA rather than $0. :)
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I have had a similar idea

Post by billern » Wed Feb 06, 2008 12:15 pm

If a person can afford to fund a Roth IRA after contributing enough to their 401k to get company match (and they are eligible to fund the Roth), they should fund it.

Since the Roth IRA is tax sheltered, it is the place to invest in tax inefficient investments like CDs, bonds, reits, CCFs (which I am not a big fan of), and actively managed mutual funds (yuck!).

If a person plans on buying a house in X years, they should fund their Roth IRA and start saving up for the house by investing in CDs/bonds in it. If they can save money beyond the funding limit of the Roth IRA, they should invest in tax efficient investments in a taxable account. Total market, total market ex-us, etc. The interest income will compound tax-free in the Roth IRA while the tax efficient investments in the taxable account will be taxed at lower rates. When the time comes to get the down-payment to buy the house, they can sell their taxable investments first and then withdraw money from the Roth. They will pay long term capital gains on the appreciation in the taxable account and be able to keep some money in the Roth. Afterwards, they can shift the money in the Roth towards what you would expect in a retirement portfolio.

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Post by leonard » Wed Feb 06, 2008 2:13 pm

Taylor - this is a great issue. Many people should probably consider this in their investment approach, especially starting out.

I do not think people should plan to put money in to a Roth, with the plan of withdrawing for a house down payment. This money has the longest time frame for compounding for retirement and this long term compounding should not be passed up. Also, if a person will have taxable investments, then of course the tax free space is valuable for your tax inefficient asset classes.

There is only one situation where I would even consider putting money in a Roth that I might consider withdrawing. If a person is not able to fund an emergency fund in taxable and a Roth at the same time, then I can see someone funding a Roth in lieu of a taxable emergency fund. Then, once the Roth is fully funded, immediately building a emergency reserve in taxable. However, it would need to be a true emergency fund that only has a remote chance of needing to be accessed.

EDIT: I would add. Generally, I think someone has much more flexibility to deal with a short fall in housing - especially when younger - than you do with a shortfall for retirement. Assuming your not at the poverty level, you can buy less house than you want, rent, move to a different/cheaper market, etc to address housing needs. If you come up short for retirement, I think you have fewer options to react. I would rather overfund my retirement (what a problem to have!) than have a house a couple years sooner.
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Thank you!

Post by SeeMee » Wed Feb 06, 2008 9:24 pm

This thread has been very interesting and informative. I'm a newer poster but have been reading the forum for awhile. I recently posted and received some great advice for my AA.

I think the important thing that people are saying about using an IRA to save for a home purchase, is that the money in the IRA would not have been there otherwise. I'm 24 and I've been contributing to a Roth IRA with the idea that I could potentially use that money for a house. I am saving outside of my retirement accounts as much as I can and hope that I DON'T have to use my Roth IRA money... but I don't think it will kill me if I do. I'm not sure when I will decide to buy a house/apartment and obviously that will factor into my decision. I have a lot saved in my 401K for retirement and will have more when the time comes to make that decision. If I have to use some of my Roth IRA, I will be comfortable knowing that I have prepared.

I wasn't aware (but am now...thanks to this post) that the money taken from a Roth IRA can't be returned. I'm definitely going to try to save more in taxable accounts so I don't have to touch my IRA if possible.

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