Pay Down Mortgage or Save Larger Down Payment.

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frenchje
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Pay Down Mortgage or Save Larger Down Payment.

Post by frenchje »

I have a dilemma I am trying to figure out regarding our home. We recently were married and she has owned the home for more than a year. We both contribute to both a 401k and a Roth IRA each. In about 2 months or so we will have a fully funded emergency fund and I'm trying to decide what to do with about $1000-$1500 a month we will have to save after that is completed. Currently we owe 100k on the original 106k mortgage. I think PMI is around $45 month. We would like to purchase a new home in the future and currently we figure we would like to move in about 3 years. Just looking around currently houses we like are around $250-$300k. My first thought is that we should save everything for a sizeable down payment to avoid PMI and give us some equity. However our current home is probably worth somewhere between $90-$100k based on comparables in the area. So I'm currently trying to figure out what makes the most sense. As I see it I have several options:

1. Save money for down payment and if we have to sell the current house for a loss use some of that money to cover it.
2. Pay down current mortgage by 5-10k now to get it more equitable then save as much towards a down payment as we can.
3. Pay down current mortgage to get rid of PMI and save slightly less towards a down payment.
4. Pay down the mortgage as much as possible and use any equity gained to help with the new house's mortgage.

What would you bogleheads suggest? What would be the pros and cons to these differing options?
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rdmayo21
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Re: Pay Down Mortgage or Save Larger Down Payment.

Post by rdmayo21 »

May I ask why you are wanting to move? Jumping around a lot will likely cost you more than anything else.
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linuxuser
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Re: Pay Down Mortgage or Save Larger Down Payment.

Post by linuxuser »

rdmayo21 wrote:May I ask why you are wanting to move? Jumping around a lot will likely cost you more than anything else.
+1

6% commission on $100K house is still $6K
Topic Author
frenchje
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Re: Pay Down Mortgage or Save Larger Down Payment.

Post by frenchje »

Yes I know that selling/buying a house will cost money and we've already taken that into account. There are many factors that are in play here causing us to want to look for a different housing situation. She bought the house before we were together and while it's a nice home just doesn't fit what we are envisioning for our future. But I wasn't asking whether we should move or not as that decision is pretty much made already. I was asking for specific advice in relation to what our goals are as I wrote in my original message.
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rdmayo21
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Re: Pay Down Mortgage or Save Larger Down Payment.

Post by rdmayo21 »

frenchje wrote:Yes I know that selling/buying a house will cost money and we've already taken that into account. There are many factors that are in play here causing us to want to look for a different housing situation. She bought the house before we were together and while it's a nice home just doesn't fit what we are envisioning for our future. But I wasn't asking whether we should move or not as that decision is pretty much made already. I was asking for specific advice in relation to what our goals are as I wrote in my original message.
In that case, I think #3 sounds good.
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bengal22
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Re: Pay Down Mortgage or Save Larger Down Payment.

Post by bengal22 »

I have always chosen option #1. I think you are always better investing for future goals(in this case a bigger house) than paying towards the mortgage. In many ways it will all shake out at the closing anyway when assets and liabilities are accounted for so you might as well get in the habit of investing and taking advantage of the mortgage interest tax deduction.

Good luck.
"Earn All You Can; Give All You Can; Save All You Can." .... John Wesley
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grabiner
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Re: Pay Down Mortgage or Save Larger Down Payment.

Post by grabiner »

I would suggest paying down the current mortgage. Since this gets rid of PMI, you will get extra money in your pocket for the next few years. And since your payment will reduce your mortgage principal, you will have more equity in your own house.

When you are ready to move, you will get that equity back (with interest) from the sale; if you buy your new house before selling the current one, you can take a bridge loan against the current house to take out the money you need for a down payment. Thus investing in your current home equity is additional savings towards your down payment, and you will get the benefit when you sell.

Another advantage of paying down your current mortgage is that, if you choose to stay in your current home, you can refinance as soon as you have enough equity. If you are saving an extra $1000 per month, then you can probably afford to refinance from your current 30-year loan to a 10-year loan as soon as the bank will let you do that.
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Toons
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Re: Pay Down Mortgage or Save Larger Down Payment.

Post by Toons »

rdmayo21 wrote:
frenchje wrote:Yes I know that selling/buying a house will cost money and we've already taken that into account. There are many factors that are in play here causing us to want to look for a different housing situation. She bought the house before we were together and while it's a nice home just doesn't fit what we are envisioning for our future. But I wasn't asking whether we should move or not as that decision is pretty much made already. I was asking for specific advice in relation to what our goals are as I wrote in my original message.
In that case, I think #3 sounds good.
+1 :happy
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Shnaka
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Re: Pay Down Mortgage or Save Larger Down Payment.

Post by Shnaka »

Paying down any mortgage yields a return of exactly what your interest rate on said mortgage is, unfortunately, it does not lower your payment. Be sure just because you get your LTV to an acceptable margin (typically 80%) that the PMI wont remain. Many PMI plans have LTV AS WELL AS time frame minimums. Know what your time frame minimum is if you have one, some are as long as 5 years.

If your goal is to buy a bigger house paying down your current house will not help you qualify for a new loan as your debt (monthly obligations) to income will not change (unless your income goes up) since on a 30 year fixed loan, no matter how much you pay it down, your monthly payment amount remains the same (not considering a release of PMI).

If I were you I would keep the current house as an investment (assuming you can at least break even in 3 years), save for a down payment on your next house, and talk to a mortgage broker ASAP.
Agentwilder
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Re: Pay Down Mortgage or Save Larger Down Payment.

Post by Agentwilder »

Your decision to move is final but are you sure you want to sell your current home in 3 years?

If you save $1500/mo for the next 3 years that money should cover a 20% down payment on a new house without having to sell your current home. You never know what housing prices are going to do. You may put 50K into your current home and only walk away with 30k to use as a down payment. IMHO, you should save the extra cash for a down payment and keep your current home as a rental. Even if just to wait for an ideal opportunity to sell. With any investment you should try to avoid being forced to sell. I think this plan leaves you the most options. Of course you will be highly leveraged in real estate but why not have someone else pay your mortgage for you and sell when it benefits you the most?
Bob's not my name
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Re: Pay Down Mortgage or Save Larger Down Payment.

Post by Bob's not my name »

Why is PMI bad on a future home but not bad on your current home? PMI means you're borrowing the missing down payment at above 10%. If you can make better than 10%, guaranteed and after taxes, in another investment, do that.
NorCalDad
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Re: Pay Down Mortgage or Save Larger Down Payment.

Post by NorCalDad »

I don't know what the market looks like in your area, but where I live, there are bidding wars in the most desirable neighborhoods and having the contingency of having to sell your current home can make buying more challenging. It's tough enough having no contingencies and 20% down when there are buyers/investors offering 100% cash. Just a thought if you're considering putting your equity in your current home rather than saving for the next house in cash.

To me, it comes down to your time horizon.

If you're sure you need to move within 3 years, go with Option #1. It's the option we chose when we were in your shoes a few years ago (though we didn't have PMI, which makes your calculation a little different). You maintain the most flexibility that way. I think you will definitely have to delay your next purchase beyond 3 years if you decide to focus on your current mortgage (saving $1500/month will barely get you enough for 20% down on the homes you're talking about). There are downsides, however: you keep paying PMI and you will earn less on your savings than you would gain by prepaying your mortgage.

If you are fine waiting 4-7 years, then I might choose Option #3 of getting rid of PMI and building sufficient equity in your current home before starting your next home fund.
porcupine
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Re: Pay Down Mortgage or Save Larger Down Payment.

Post by porcupine »

The way I see it, here is a bucket list of options (read through until you fall into one of the buckets):

1) If you can afford the mortgage of two houses at the same time (in the future), then save for a larger down payment.

2) If not, i.e., you've got to get rid of current home before/while buying the new one then, from now until the time to buy ...

a) if you think the housing market will hold steady or appreciate, then pay down current mortgage. Also, sell current house before buying new one.

b) if you think the housing market will depreciate and if you can afford to sell current home at a loss, then save for a larger down payment and buy new home.

c) if you think the housing market will depreciate and if you cannot afford to sell current home at a loss, you cannot buy new home (we are past option 1, where you can afford the mortgages of two houses at the same time).

- Porcupine
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N1CKV
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Re: Pay Down Mortgage or Save Larger Down Payment.

Post by N1CKV »

I am in a similar predicament except I am single and plan to stay that way and I am beyond PMI payments.
Currently I have roughly $1,200/ mo "leftover" after all is said and done. I am socking that money away in a "high interest" savings account for my next down payment. I'm not 100% sure I will sell my current home or if I will keep it as a rental (currently the identical house next door rents for ~$300/ mo over my house note which includes full escrows) - either way I have options.

For your situation, considering PMI I would look at #3, HOWEVER - as previously mentioned you need to look in to the procedure and requirements to drop PMI. My loan (non-FHA) required 2 years minimum and a reappraisal confirming current LTV of 80% or paying down to beyond a certain percent of purchase price vs. current principle (it was less than 80%, I don't recall). I recently heard of someone who purchased and is locked in to PMI for a minimum of 5 yrs on a FHA loan.

I will never pay PMI again.
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goggles
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Re: Pay Down Mortgage or Save Larger Down Payment.

Post by goggles »

You will be in a position to pay off your house completely in 56 months if you prepay $1500 per month on a $100k balance, according to an online calculator that I used. And that's with 5% interest (just a guess on my part). You should do the calculations yourself.

If you can pay off your house completely in less than five years, you should think seriously about doing so. A paid off mortgage means you have freedom and a lot more free cash. A bigger house may be nice, but it'll take you many many years of work just to pay the bills.

At the very least get rid of the PMI. That is just a complete waste to pay it when you can afford to get out of it.
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