Paying Mortgage v Saving Down Payment

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brocker
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Joined: Sat May 12, 2018 9:16 am

Paying Mortgage v Saving Down Payment

Post by brocker » Sat May 12, 2018 10:40 am

Hi,
I have a specific goal that I am trying to accomplish in the next 2 or 3 years. We (wife, 3 young kids) would like to pay off our current house and begin renting it out. It will likely be worth 400K+ and we will be trying to move into a house that will likely cost 600-700K. I don't feel comfortable having 2 mortgages, so we want our current house to become a cash producing asset as a rental. I also don't want to pay PMI on the next house, so I want to save up 150K or so for the down payment before we make the move.

My questions is, what is the best way to go about arriving at a paid for house with 150K saved for a down payment in the next 2-3 years? Our mortgage interest rate is 2.875, and we currently owe 118K. We can usually pay 5K-8K per month right now on the mortgage. The minimum payment is 2400.

I am wondering if we should be investing more into an intermediate term bond fund, or possibly a tax exempt muni bond fund (VMITX?) that would have a better yield thaN what we are getting from paying down the mortgage. In other words, in saving the 150K, what would be the best type of fund? I make approximately 300K per year, so we are in a high tax bracket. Does it make more sense to save the down payment first, and then pay off the mortgage?

I know that some would say that since the mortgage rate is so low, that we should hold onto it forever, but we just don't have that kind of risk tolerance (to have 2 mortgages). The move is going to be in the same zip code (we love the area and the kids are in great schools), so we are doing it to 1) begin making rental income and 2) because we need more space as the kids become teenagers.

Thanks so much for any advice on the best way to accomplish this goal!

mortfree
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Re: Paying Mortgage v Saving Down Payment

Post by mortfree » Sat May 12, 2018 2:17 pm

Are there tax benefits if you keep the mortgage on the rental?

If you are paying 5-8k per month now, isn’t that like having two mortgages?

And the rent should cover the mortgage anyways.

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grabiner
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Re: Paying Mortgage v Saving Down Payment

Post by grabiner » Sat May 12, 2018 6:51 pm

brocker wrote:
Sat May 12, 2018 10:40 am
I am wondering if we should be investing more into an intermediate term bond fund, or possibly a tax exempt muni bond fund (VMITX?) that would have a better yield thaN what we are getting from paying down the mortgage. In other words, in saving the 150K, what would be the best type of fund? I make approximately 300K per year, so we are in a high tax bracket. Does it make more sense to save the down payment first, and then pay off the mortgage?
This is the right comparison to make; see Paying down loans versus investing on the wiki.

Are you deducting the mortgage interest under the new tax law? (Most married couples are not, because you need $14,000 in deductions other than state and local taxes in order to itemize; unless you donate a lot to charity, you probably won't reach that.) If not, then paying down the mortgage is a risk-free, tax-free 2.875% return. If you do deduct the interest, then paying it down is a risk-free, taxable 2.875% return, which is less than you can earn on low-risk, tax-free municipal bonds.

However, if you keep the mortgage on the rental, then it will be tax-deductible even if you don't itemize deductions, which makes keeping it at a low rate particularly attractive. You can keep a "mortgage payoff fund" in munis and make the mortgage payments from that fund.
Wiki David Grabiner

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FiveK
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Re: Paying Mortgage v Saving Down Payment

Post by FiveK » Sat May 12, 2018 9:07 pm

Just adding another vote to "pay only the monthly minimum on the current mortgage" because
- that will aid your goal to accumulate the down payment for the new house
- especially once you can deduct the interest as a rental expense, the pre-payment becomes an even lower return than it is now.

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