Math help with interesting mortgage decision!

[aks40655]

I'm purchasing a $2m home in California. My employer offers an interesting mortgage assistance program for a second mortgage. Essentially, they will offer a second mortgage of up to $400K as long as I pay at least 5% down ($50K). On this second mortage, all interest is completely forgiven the first five years, the payments do not start until year 6, the total loan term is 25 years, and half of the loan is forgiven in 1/3 increments at years 10, 15, and 20, but that is treated as income that year. So, on a $400K loan, $200K of it will be completely forgiven by year 20, and I'll take a tax hit of about $100K (50% tax roughly) over the life of the loan.

My options are:
1) Put $400K down in cash. Take a $1.2m loan through a primary bank. Take a $400K loan through my employer.
2) Put $50K down in cash. Take a $1.55m loan through a primary bank. Take a $400K loan through my employer. Invest the remaining $350K cash in a long-term index fund.

Which would you do? My gut says #1 as it keeps my debt down. But my gut math says #2 because I can make more by borrowing money at 6% and investing it for long-term yields of >6%. Also, what are your thoughts on the assistance program?

[pizzy]

I'm purchasing a $2m home in California. My employer offers an interesting mortgage assistance program for a second mortgage. Essentially, they will offer a second mortgage of up to $400K as long as I pay at least 5% down ($50K). On this second mortage, all interest is completely forgiven the first five years, the payments do not start until year 6, the total loan term is 25 years, and half of the loan is forgiven in 1/3 increments at years 10, 15, and 20, but that is treated as income that year. So, on a $400K loan, $200K of it will be completely forgiven by year 20, and I'll take a tax hit of about $100K (50% tax roughly) over the life of the loan.

My options are:
1) Put $400K down in cash. Take a $1.2m loan through a primary bank. Take a $400K loan through my employer.
2) Put $50K down in cash. Take a $1.55m loan through a primary bank. Take a $400K loan through my employer. Invest the remaining $350K cash in a long-term index fund.

Which would you do? My gut says #1 as it keeps my debt down. But my gut math says #2 because I can make more by borrowing money at 6% and investing it for long-term yields of >6%. Also, what are your thoughts on the assistance program?

Absent the house/employer for a second, would you borrow at 6% to invest in the stock market?

I wouldn't at 6%.

[rob]

If you were let go from this employer - would you stay in CA?

If Yes - I would do #1 no question
If No - I might think about #2... but #1 is the most sound IMO anyway.

[humblecoder]

Regarding thoughts on the assistance program, unless I missed it, you didn't state what happens if you leave the employer? Die? Are disabled? Etc.

That nugget of information is needed in order for someone to answer your question about what people think about this assistance program.

[exodusNH]

I'm purchasing a $2m home in California. My employer offers an interesting mortgage assistance program for a second mortgage. Essentially, they will offer a second mortgage of up to $400K as long as I pay at least 5% down ($50K). On this second mortage, all interest is completely forgiven the first five years, the payments do not start until year 6, the total loan term is 25 years, and half of the loan is forgiven in 1/3 increments at years 10, 15, and 20, but that is treated as income that year. So, on a $400K loan, $200K of it will be completely forgiven by year 20, and I'll take a tax hit of about $100K (50% tax roughly) over the life of the loan.

My options are:
1) Put $400K down in cash. Take a $1.2m loan through a primary bank. Take a $400K loan through my employer.
2) Put $50K down in cash. Take a $1.55m loan through a primary bank. Take a $400K loan through my employer. Invest the remaining $350K cash in a long-term index fund.

Which would you do? My gut says #1 as it keeps my debt down. But my gut math says #2 because I can make more by borrowing money at 6% and investing it for long-term yields of >6%. Also, what are your thoughts on the assistance program?

I would put the minimum down to get the best rate. You can choose to pay more than the minimum if you choose, but this leaves you with flexibility.

A 6% mortgage requires anywhere from a ~7%-11% return before tax to break even. That's within the historical range of returns, meaning you're not going to make a lot in arbitrage. Obviously, some of the mortgage interest will be deductive, which lowers that number, but you'll still have a good chunk that can't be deducted.

California is a non-recourse state. If things get bad, you can walk away and not worry about the mortgage company trying to get additional assets.

[JBTX]

I don’t understand why those choices. So you’ve decided to do the employer loan in both scenarios, but the difference is how much to finance with a bank mortgage of which we don’t know the rate.

[cchrissyy]

i'm not sure you are thinking correctly about the "tax hit" of having some of the loan forgiven. everything you borrow from the bank, you will be paying back with after-tax dollars. so there is a "tax hit" there as well, you just aren't attributing it to the larger mortgage.

[pizzy]

I don’t understand why those choices. So you’ve decided to do the employer loan in both scenarios, but the difference is how much to finance with a bank mortgage of which we don’t know the rate.

"borrowing money at 6%"

[JBTX]

I don’t understand why those choices. So you’ve decided to do the employer loan in both scenarios, but the difference is how much to finance with a bank mortgage of which we don’t know the rate.

"borrowing money at 6%"

Ok. I wouldn’t borrow at 6% unless I had to.

[tashnewbie]

Regarding thoughts on the assistance program, unless I missed it, you didn't state what happens if you leave the employer? Die? Are disabled? Etc.

That nugget of information is needed in order for someone to answer your question about what people think about this assistance program.

I agree.

I would be wary of connecting my financial life any further with an employer.

I also wouldn't borrow at 6% to invest.

[knowledge]

It's an interesting program from your employer, but as others have asked, what happens if you are no longer employed by your employer? Does everything become due at once? Look into those details.

[lakpr]

Note that the amount of interest attributable to principal more than $750k is not tax deductible on Federal tax return, and interest paid on principal more than $1 million is not tax deductible on the California state tax return.

Therefore, the 6% loan you are taking on the $350k difference (between option 1 and option 2) is completely after-tax rate. Therefore, assuming you are in the 24% Federal + 9.3% state marginal tax bracket (otherwise you wouldn't be able to afford the $1.5 million home in the first place), you need to earn around 9% in any alternative investment you make.

There are no guaranteed investments that would yield 9% year-in and year-out for 25 years continuously.

Take Option #1, put $400k down. Even more if you can, get the principal amount on the mortgage to $1 million at least, to $750k if you can.

[runningshoes]

I'm purchasing a $2m home in California. My employer offers an interesting mortgage assistance program for a second mortgage. Essentially, they will offer a second mortgage of up to $400K as long as I pay at least 5% down ($50K). On this second mortage, all interest is completely forgiven the first five years, the payments do not start until year 6, the total loan term is 25 years, and half of the loan is forgiven in 1/3 increments at years 10, 15, and 20, but that is treated as income that year. So, on a $400K loan, $200K of it will be completely forgiven by year 20, and I'll take a tax hit of about $100K (50% tax roughly) over the life of the loan.

My options are:
1) Put $400K down in cash. Take a $1.2m loan through a primary bank. Take a $400K loan through my employer.
2) Put $50K down in cash. Take a $1.55m loan through a primary bank. Take a $400K loan through my employer. Invest the remaining $350K cash in a long-term index fund.

Which would you do? My gut says #1 as it keeps my debt down. But my gut math says #2 because I can make more by borrowing money at 6% and investing it for long-term yields of >6%. Also, what are your thoughts on the assistance program?

A few points, not repeating what others have highlighted;
1. If your written math on 5% of a $2MM home is $50k, you should ignore your gut math and stick to the safe path of the smaller mortgage
2. In today's environment, it's not clear that your Option 2 even exists - the bank is highly unlikely to let you buy with that much leverage

[aks40655]

Thanks all! I agree the question of what happens if I am no longer employed by them is a big one. I’d have to pay back the balance within 4 months of termination.

[aks40655]

Touché. Extremely embarrassed of that error and I pride myself on my number sense.

A few points, not repeating what others have highlighted;
1. If your written math on 5% of a $2MM home is $50k, you should ignore your gut math and stick to the safe path of the smaller mortgage
2. In today's environment, it's not clear that your Option 2 even exists - the bank is highly unlikely to let you buy with that much leverage

[humblecoder]

Thanks all! I agree the question of what happens if I am no longer employed by them is a big one. I’d have to pay back the balance within 4 months of termination.

If I were you, I would think about how you would handle certain contingencies if you are no longer employed and the loan comes due. For most people, $400K isn't something that they have lying around "just in case". Consider that if your termination of employment is due to job loss or disability, you might not be able to refinance that into a bank loan, given you have no income. That means that you are likely going to need to have $400K stashed away in a safe account. Or you will need to be prepared to move. Or execute some other option which isn't coming to mind at the moment (I'm sure the intelligent people on this board can point out some other options).

That would also have the side effect of making me lean away from your Option #2, since I wouldn't want to add more risk to the situation.

And if you die, you need to make sure that you have enough in life insurance to repay the $400K (unless you are single, in which case it probably doesn't matter).

[gatorking]

Thanks all! I agree the question of what happens if I am no longer employed by them is a big one. I’d have to pay back the balance within 4 months of termination.

So you have 4 months to refinance.

[toddthebod]

I'm purchasing a $2m home in California. My employer offers an interesting mortgage assistance program for a second mortgage. Essentially, they will offer a second mortgage of up to $400K as long as I pay at least 5% down ($50K). On this second mortage, all interest is completely forgiven the first five years, the payments do not start until year 6, the total loan term is 25 years, and half of the loan is forgiven in 1/3 increments at years 10, 15, and 20, but that is treated as income that year. So, on a $400K loan, $200K of it will be completely forgiven by year 20, and I'll take a tax hit of about $100K (50% tax roughly) over the life of the loan.

My options are:
1) Put $400K down in cash. Take a $1.2m loan through a primary bank. Take a $400K loan through my employer.
2) Put $50K down in cash. Take a $1.55m loan through a primary bank. Take a $400K loan through my employer. Invest the remaining $350K cash in a long-term index fund.

Which would you do? My gut says #1 as it keeps my debt down. But my gut math says #2 because I can make more by borrowing money at 6% and investing it for long-term yields of >6%. Also, what are your thoughts on the assistance program?

How secure is your job? What happens in a repeat of 2009? You get laid off, the market crashes, and now you need to come up with several hundred thousand dollars to repay your employer while being unable to refinance due to losing your job. Now you have to sell what was a million dollars in assets last year before the crash in order to pay off the loan.