When buying a house, pay as much as possible, or contribute to your PP instead?

[Pointedstick]

This is probably a pretty common topic, but I thought I'd bring it up again. With mortgage rates at historic lows compared to the average PP performance, I keep thinking about how for a PP investor who's about to buy a house, it would make logical sense to put down the minimum 20%, and invest the remainder of the sum that you could have added to the down payment into your PP. Then you'd be growing your investments faster, while retaining the flexibility to use that larger sum to pay down/off your mortgage if you ever felt like it.

...But on the other hand, if you've progressed beyond the "monthly payment" mindset, then you can see a mortgage-free house as the opportunity to live without housing payments. Putting down like 70% or even paying entirely in cash might drain your liquid financial assets in the short term, but it gives you a real asset that you own entirely and can't lose to creditors much sooner. The more rapid elimination of a $500-$1,500 monthly payment frees up that much of your income to be put into investments, while simultaneously giving you the safety of a dwelling you own free and clear.

I'd love to hear what have others here done in this situation.

[WiseOne]

I've been racking my brains over this very topic.  So glad you brought this up.

I didn't reason this out in advance, but my take on this has shifted with the mortgage rates (I've refinanced twice).  For what it's worth, I'm in general very much in favor of paying down debt rather than building investments, as one is a guaranteed return and the other is not.  It's a personal choice though.

I put 25% down when I bought 5 years ago.  Since then:
6% mortgage rate:  All taxable savings went to prepay the mortgage.
4.5% mortgage rate:  Taxable savings divided between prepayment and investments.
2.75% mortgage rate:  I took a chunk of savings and did a cash-in refinance to a 15 year loan at this rate, to match the payment on my previous 30 year loan.  Equity is now 40%.  For the immediate future, the plan is not to prepay the mortgage, but instead build up taxable investments, on the theory that they should grow faster than 2.75% nominal.  If deflation returns, I'll likely go back to prepaying the mortgage.

I doubt you'd want to plunge into home buying purely for the investment benefits, though.  I calculated what my "rent" is now (maintenance + mortgage interest - tax benefit) and compared it to the rent on my old apartment plus a presumed 5% return on the amount that is currently tied up in equity.  They came in about the same.  The benefit of buying has been the increased security and control that comes with ownership, plus the promise of a far-off future with no mortgage payments and the possibility of increased home value.  The cost, of course, is that I now have to deal with a lot more than slipping the rent check under the landlord's door once a month  .

Another argument for buying a home for cash:  a) no closing costs related to the mortgage, and b) if you have cash you can probably talk down a seller lower than if you needed to get a mortgage.

[dualstow]

I paid for my home in full when I bought it 12 years ago, but I had a little bit of interest-free help.
It's been nice (and simple) having only to focus on rising real estate taxes and roof & renovation bills, but everyone who is richer and smarter than me seems to have taken the WiseOne route. Not just Mark Zuckerberg, but people I know personally.

[Pointedstick]

Dualstow, would you mind talking a little about your renovation bills? Are these mandatory (e.g. your water heater goes kaput) or discretionary? I keep hearing that houses are money pits, but I wonder how much of that you can avoid by doing repairs yourself. Even with your house paid off, are you paying anything close to what you would have been paying in rent or with a mortgage?

Also, why do roofs require such costly repairs? Everyone I know who owns a home complains about their roof! Is it because shingle roofs need regular replacement, or are these cases where the roof was shoddily-constructed from the get-go? I wonder how much of that you could mitigate by replacing it with a metal roof whose surface at least is supposed to last darn near forever.

My general life concern right now is reducing expenditures as much as possible, so if home ownership entails a never-ending stream of unexpected repair payments as it gradually falls apart, that doesn't sounds like a great deal. 

[WiseOne]

Sounds to me like buying your home for cash 12 years ago was pretty smart!

I just didn't want to be paying rent after retirement.  Going the mortgage route was the only way I could see to get there, but it's cost several gray hairs - like when Bank of America lost my coop documents but wouldn't admit it until after the lock period expired on refinance #2.  They were technically in violation of the law but they pulled rank on me so there was nothing I could do except pay the fees and be thankful I would never have to deal with BoA again.

[BearBones]

2.75% mortgage rate:  I took a chunk of savings and did a cash-in refinance to a 15 year loan at this rate, to match the payment on my previous 30 year loan.

Paid off my home in 2002, since I was (surprise, surprise) rather bearish on traditional investments (and I  had no idea about the concepts of the PP).  Hard to believe that rates are 2.75%, so it would be a tough choice now.

I guess the decision partly comes down to whether you think that you can safely and predictably earn 2.75 nominal on you investments. When rates were 7+%, this seemed like a fools bet. If I were doing it now, I might take the mortgage, as you have done WiseOne.

[BearBones]

My general life concern right now is reducing expenditures as much as possible, so if home ownership entails a never-ending stream of unexpected repair payments as it gradually falls apart, that doesn't sounds like a great deal. 

It's a drain, even if you do it yourself. But the expenditure is obviously going to be less than renting an identical property.

As you and other ERE folks know, the home expenditures depend so much on the size and the construction. Modest size also equals lower insurance (if you choose this) and lower taxes. So my next move is into a smaller house built like a rock (or even out of rock).

[Coffee]

I paid off the note, a few years ago.  I had three or four really good years with my business, and just decided it was smart to diversify and have part of my money in something I could touch and feel.  Also-- since I own an internet-based business, I never know if it's going to be, "here today, gone tomorrow."

Then I sold that house because it was way bigger than we needed (and had three different associations, two AC units and a PIA pool that was a money pit).  We didn't like the Vegas heat, either.  So we sold it and moved North.

We bought a much smaller, one level house that was built back when they were building quality houses and not just slappin' them together.  No association fees, no HOA, no pool.  I've had three different contractors and inspectors look at the house and comment how well-built it is, although it was a bit of a cosmetic fixer.

Put about $30k into getting it how we like it, including repaving the driveway, interior paint and flooring, water heater, etc...  That wasn't completely necessary, but I'm planning on staying here for at least another 20 years.  (I'm 42.)

We've been in this house for about a year now and we absolutely love it.  Way, way less than we were paying back when we were servicing a note, too.  Not even close.  Utilities are far less, also.  So... buy wisely.

Probably after 10-15 years, it'll need a new roof and I'll put one of those 50 year roofs on it. 

As to my motivation for buying it outright instead of financing: While it's not an investment per se, I like Browne's idea of not using leverage.  I also like Dave Ramsey's point about: If you lost your job, how long could you go?

Without a mortgage or rent payment... we could go a long while.

[AgAuMoney]

The issue is cashflow.

You don't need assets.  Unless you are completely self-sufficient, you need cashflow.

You can generate cashflow in many ways.  You can work, beg, put your assets out to lend (bonds) or out to work (buy a business(s) or shares of a business(s)), or simply deplete your assets.

A mortgage will increase your required cashflow.  Buying a house with no mortgage will deplete your assets.

Which makes you more or less comfortable?

Perceptually (or quantifiably if you can put numbers to it) is there a lower risk to you in needing higher cashflow or in having fewer assets?

Personally, I've never been in a position where I could have purchased my house with cash (maybe just barely if I could have liquidated my 401(k) without paying taxes on it).  So I have a mortgage plus a HELOC currently nearly maxed which let me keep my assets instead of liquidating some during some recent cashflow tribulations.  So you know which direction I lean.

Currently my mortgage is approximately 25% of my liquid assets (mostly in retirement accounts).  Guaranteed funds are sufficient to pay the mortgage and other living expenses for a year or more barring armageddon (in which case I'm not paying my mortgage).  I'm pretty comfortable in this situation, knowing I have several ways of making payments for a long time should my paychecks stop.  I'm more comfortable than I would be depleting assets, paying off the mortgage, and living on the edge until building up my reserves again.  Take at least 10 years or so to recover.

Another 15 years and both the primary and HELOC will be paid off.  The extra 5 years is interest.

I'm watching those assets grow, and at some point the equation for me will tilt in favor of paying off the mortgage and thus reducing my assets and simultaneously reducing my required cashflow.  I know if gold and silver were to double twice I would be at that point.  But there are many other ways of reaching the same point...  But I don't know if I'll reach it before naturally paying off the mortgage.  My mortgage is reducing by about $10,000 this year and the rate of decrease is increasing every year (as the portion of each payment going to interest is now well under 50%).  So at some point the asset and debt lines will cross and I'll pay off the house.  I just don't yet know when.

Good luck in your decision.

[Tyler]

I recently bought a house, and went though the same thought process.

For me, a 15-year fixed mortgage near 2.75% seemed best in the wealth accumulation phase by keeping cash free for investment return while greatly reducing interest paid relative to a 30-year mortgage. And I still have the ability to pay off my mortgage early once I reach my ER savings goal and want to lock in the lowest annual expenses to minimize risk.

[KevinW]

Also, why do roofs require such costly repairs? Everyone I know who owns a home complains about their roof! Is it because shingle roofs need regular replacement, or are these cases where the roof was shoddily-constructed from the get-go? I wonder how much of that you could mitigate by replacing it with a metal roof whose surface at least is supposed to last darn near forever.

They need regular replacement. Shingles get worn out due to exposure to the elements. Then the old ones need to be pulled up and new ones laid down. Basically constructing a new roof covering. It's hot, messy, dangerous, labor intensive work. This is a big lumpy expense that comes up every few years which can make it a tricky household budgeting problem.

Metal roofs last much longer, but not forever. IIRC roughly 50 years. Some people dislike their appearance, or their loudness during rainfall, which might affect resale value.

Living green roofs last indefinitely since they "heal," but require care and are difficult and/or illegal to retrofit.

[Pointedstick]

The issue is cashflow.

You don't need assets.  Unless you are completely self-sufficient, you need cashflow.

You can generate cashflow in many ways.  You can work, beg, put your assets out to lend (bonds) or out to work (buy a business(s) or shares of a business(s)), or simply deplete your assets.

A mortgage will increase your required cashflow.  Buying a house with no mortgage will deplete your assets.

Which makes you more or less comfortable?

That's a very succinct way to put it. Since ERE is my goal, and the basic premise of ERE is the minimize your need for cashflow, my preference is to buy a modest house for cold hard cash. But this has lead me to two pertinent questions:

1) At such low mortgage rates, even with ERE as a goal, does it make sense to forgo higher safe investment returns from the cash tied up in the house? Both the house and the investment portfolio serve ERE goals; would it make sense to deliberately depress one in order to reach the other more quickly?

2) At what point does a house become such a money pit that it isn't actually reducing your need for cashflow because something's always falling apart? The last thing I would want is to buy a house only to discover over the years that it needs a new roof, new walls, new plumbing, new wiring, and new foundation. Has anybody got recommendations for how to reduce ongoing maintenance costs or keep them from occuring in the first place?

This is all academic right now since where I live, 100k wouldn't buy you a cardboard box under a bridge, but elsewhere, for any house above 60k, I would be extremely tempted to go for a 2.x% 15-yr mortgage and put the rest into my PP.

[craigr]

A home to live in is a consumption item, not an investment. If you feel it is worth it to you, then put the money towards it. But don't look at it as an "investment" as commonly portrayed, because it definitely is not.

[Pointedstick]

A home to live in is a consumption item, not an investment. If you feel it is worth it to you, then put the money towards it. But don't look at it as an "investment" as commonly portrayed, because it definitely is not.

Agree completely. But borrowing to buy a house would not be because I anticipated selling it for more in the future; rather it would because I anticipated the PP returning far more than 2.x% nominal during the duration of the mortgage. I view a house (especially a paid-off one) as a vehicle for reducing monthly expenditures, not a freestanding bank account. And I'm still not sure I even like the option of a low-interest mortgage if I could pay in cash. It would be very tempting. That's why I'm thinking that I would have a hard time deciding. Obviously if mortgage interest rates were 7%, it would be a no-brainer.

[KevinW]

IMO, FI has two major components, 1) a paid off home and 2) a liquid asset portfolio that can support all other expenses. In the spirit of diversification, I think a decent rule of thumb is to have both on track to complete at about the same time. If you're 30 years out from retirement, a 30 year mortgage with 10-20% down is reasonable. If you're on a 5 year ERE plan you might as well buy in cash.

On maintenance: it works like any other kind of maintenance (cars, computers, etc.). You can mix and match...
- Go minimalist and keep it as simple and small as possible.
- Phase in high durability replacements, e.g. metal roof and brick fence.
- Stay on top of preventive maintenance.
- Ignore or delay superficial repairs.
- Build something yourself. (But then you can't use any mass market services or retailers.)
- Buy a condo with an HOA that covers major repairs. (A compromise with renting.)

I've looked at this from a lot of angles, and I think the most economical thing is to buy a small and simple conventional stick built home in a good location. I've analyzed the TCO of many alternatives and they almost always work out to a wash. IMO the housing market is pretty efficient.

[BearBones]

Well put, KevenW. I like your rule of thumb, your mix 'n match, and your bottom line.

[MachineGhost]

My general life concern right now is reducing expenditures as much as possible, so if home ownership entails a never-ending stream of unexpected repair payments as it gradually falls apart, that doesn't sounds like a great deal. 

Its not just the payments, its the stress and if you are silly enough to do it yourself, a dearth of time.  Division of labor is why we can earn six figures nowadays.

Given all of the possibilities I've looked at, in the future I am leaning towards a fully furnished condo or high rise apartment where all the boring B.S. is taken care of for me.  I simply have zero interest in devaluing my mental labor for skilled labor.

But, you should start with the quants: http://contactbm.com/Rent_vs_Buy.xls

[MachineGhost]

This is all academic right now since where I live, 100k wouldn't buy you a cardboard box under a bridge, but elsewhere, for any house above 60k, I would be extremely tempted to go for a 2.x% 15-yr mortgage and put the rest into my PP.

If you are willing to live in Kansas, Nebraska or Montana, you can get free land if you are willing to build your own house on it.  Aside from those weird homes we discussed before, theres also modular, manufactured or mobile homes that cost less than traditional construction.

[Coffee]

Buying a house with no mortgage will deplete your assets.

Buying a house with no mortgage transfers one asset class (cash) to another asset class (real estate).  It does not "deplete your assets."

[Pointedstick]

Its not just the payments, its the stress and if you are silly enough to do it yourself, a dearth of time.  Division of labor is why we can earn six figures nowadays.

But I like manual labor, home renovation and repairing broken things. Things change completely if you're unwilling to do maintenance or repairs yourself, in which case indeed a furnished condo probably would be a good choice. But this is ERE I'm striving for, and part of that is "insourcing" rather than outsourcing. If I didn't already enjoy that kind of thing, I'd have given up ERE a while ago.

http://www.mrmoneymustache.com/2011/09/ ... ussypants/

Buying a house with no mortgage transfers one asset class (cash) to another asset class (real estate).  It does not "deplete your assets."

From an ERE perspective, the capital value of your house is irrelevant, because its purpose in your early retirement plans is to allow you to live free of monthly housing payments, not serve as a freestanding savings account. ERE considers an additional  sum of cash to be much more useful and powerful than an additional sum of the same size locked up in home equity, because it can be turned into investments with which to life off of.

[WiseOne]

A home to live in is a consumption item, not an investment. If you feel it is worth it to you, then put the money towards it. But don't look at it as an "investment" as commonly portrayed, because it definitely is not.

Agree completely. But borrowing to buy a house would not be because I anticipated selling it for more in the future; rather it would because I anticipated the PP returning far more than 2.x% nominal during the duration of the mortgage. I view a house (especially a paid-off one) as a vehicle for reducing monthly expenditures, not a freestanding bank account. And I'm still not sure I even like the option of a low-interest mortgage if I could pay in cash. It would be very tempting. That's why I'm thinking that I would have a hard time deciding. Obviously if mortgage interest rates were 7%, it would be a no-brainer.

I think you'd have to plug in the numbers for renting vs buying in your area in order to make that decision.  Buying almost always beats renting if your time horizon is long enough.  From what I remember you indicating (your rent = $1500/month, local condo prices = $500,000), you'd have LESS cash to invest in the immediate future if you bought because your housing costs would certainly go up.

[Figuring It Out]

The first thing we bought was a four-plex, which allowed us to pay the mortgage using tenants' money. While we have since moved on, that same four-plex now pays our property taxes and utilities on our primary residence, plus the four-plex mortgage, which will be paid off the same year our first kid goes to college.

Our goal when we bought the four-plex, having recently read Your Money Or Your Life, was to live as close to free as possible, and it's been 16+ years now that other people have paid our mortgage/abode for us.

So, this might be something to consider - buying a duplex, triplex or four-plex.

[hoost]

I'm a fan of minimizing monthly fixed expenses (and stress).  We just bought a house a couple of months ago with about 45% down, and we will put our extra income that's not going into retirement accounts toward paying off the mortgage as quickly as possible.  To me, the peace of mind of not having a house/rent payment outweighs the extra few percent I may be able to earn in the market.

[AgAuMoney]

Buying a house with no mortgage will deplete your assets.

Buying a house with no mortgage transfers one asset class (cash) to another asset class (real estate).  It does not "deplete your assets."

That is true in an absolute accounting sense.

But for practical purposes your primary residence needs to be considered different from most or all other assets you might hold.  Your primary residence generates no income, is not readily liquid, and cannot be parceled out piece by piece as needs arise, and must be replaced by something if it is sold.

For those and other reasons, most of the time your primary residence is not considered to be part of your assets.  For one specific example, see the definition of an "accredited investor."

[dualstow]

Dualstow, would you mind talking a little about your renovation bills? Are these mandatory (e.g. your water heater goes kaput) or discretionary? I keep hearing that houses are money pits, but I wonder how much of that you can avoid by doing repairs yourself. Even with your house paid off, are you paying anything close to what you would have been paying in rent or with a mortgage?

Also, why do roofs require such costly repairs? Everyone I know who owns a home complains about their roof! Is it because shingle roofs need regular replacement, or are these cases where the roof was shoddily-constructed from the get-go? I wonder how much of that you could mitigate by replacing it with a metal roof whose surface at least is supposed to last darn near forever.

My general life concern right now is reducing expenditures as much as possible, so if home ownership entails a never-ending stream of unexpected repair payments as it gradually falls apart, that doesn't sounds like a great deal. 

Hi
Shortly after I moved in, I had problems with my AC/furnace unit, and the home inspector had no way to know that the pan was mostly rusted through. So, I spent a few thousand to have that replaced.

After having the roof repaired many times and still experiencing leaky skylights, I had the entire roof replaced. $10,000 for a very small roof. It's completely flat, on a townhouse/rowhouse. Had the skylights replaced as part of it. Much better now. But, the roofers found no fewer than seven layers of old roofing underneath that they first had to remove. Yes, it was in violation of many codes, but I didn't know about it when I moved in.

I also had a water problem in the basement, and while I lost some things to damage, I didn't have to pay much to have it fixed.

Spent $30K plus on kitchen renovations, but that was not really mandatory. It was mostly to please wife #1 although it turned out to be a good idea, because the floor beneath the kitchen tile had largely been chewed up by termites long before I moved in. No termite problems since I moved in, knock on (pressure-treated) wood.

JUST THIS WEEK: I have discovered a serious problem with water getting into the bathroom floor upstairs. AND: there's a tree in the backyard that has moved since superstorm Sandy and looks like it may fall and take telephone lines with it. I'm having an arborist come out to look at it.

Are you getting the picture?  As Rosanne Rosanna Danna used to say, it's always something.

To be fair, though, I am not handy. A neighbor of mine built his entire home from a shell and saved a lot of money. I'm sure he will be much more on top of things when they start to fall apart. I am vigilant, but I don't really know what I'm doing. I have a real house with a tiny backyard in the middle of a busy city, just like I wanted. But, there is this expensive downside.

Even with steadily rising taxes and burglar alarm & other fees, I think I would be paying more if I were renting. Not sure about my choice vs mortgage.