Should You Pay Off Your Starter House or Save Money for the Next One?
Like every other aspect of life, the housing market has gone completely insane over the past few years as prices have risen by double digits in virtually every market. The median home sale price in November 2021 was 25 percent higher than two years prior , which, again, is wild . And there are no signs that this will change anytime soon. Meanwhile, as you may have noticed, inflation is huge, which means that interest rates are likely to rise.
All of this means that many people who were planning to move into a new home this year are rethinking the plan. Some people think that a market correction is about to happen and don’t want to buy right after the price peaks. Others opt out simply because their cost has been reduced. Either way, this starter home that was too small or didn’t have dream amenities suddenly starts to look nice and comfortable.
A bit of caution is always warranted, but these unprecedented circumstances could put you in an interesting situation: scraping together a down payment for a planned move and sitting on a decent amount of cash. If you’re not going to use it to buy a house right now, what should you do with it: invest or pay off your current mortgage?
do the math
One thing to keep in mind when considering this question is that buying a house is not an investment in the same sense that, say, putting a down payment in a mutual fund is an investment. We tend to use the term “investment” when discussing real estate, but it’s pretty much a metaphor: houses are a terrible investment. Yes, they tend to appreciate, but (usually) do it very slowly. They are expensive , including taxes, maintenance and insurance – whatever, there is a bill associated with it. They are not completely liquid; even in a large market, selling a house and at the same time figuring out where to move is a difficult task. And moving to a more expensive house also means additional costs.
Figuring out whether you should invest that down payment or pay off your mortgage depends on how the math works for you. The first step is to calculate how much of your current mortgage you can pay off and how much money that will save you in the long run.
For example, let’s say you have a 30-year $200,000 fixed mortgage at 4 percent and you have 10 years to maturity. You pay approximately $954.83 per month and have about $94,308.78 of principal left. Since the average down payment is around $28,000 , let’s assume you’ve saved at least that much. If you add this to your current mortgage, you’ll save about $11,000 in interest over the remainder of the loan.
Not bad! But if you invest that $28,000 in a general index fund that delivers a theoretical 8 percent return (slightly lower than the 10-11 percent that the S&P 500 typically manages), by the time you pay off your mortgage, your investment will be cost about $60,450. — a little better than $11,000.
Investing is usually better in the long run
You may have much less than $28,000 saved up, but unless your interest rate is much higher, investing your money is usually a better deal than paying off the mortgage. That doesn’t mean paying off your mortgage doesn’t come with any benefits, including keeping all that interest, paying off a lot of debt from your balance sheet, and having 100 percent equity in your home.
If you’re just putting off looking for a home and want to keep your down payment for that purpose, then how long you’re willing to wait matters. If it’s a year or less, it’s a good idea to keep the down payment somewhat liquid and affordable – a money market or savings account might be a better choice. But if you think the wait might be long and you don’t want to pay off your current mortgage with cash, you need to invest it somewhere to make a profit, if only to prevent inflation, which would otherwise only slowly reduce the purchasing power of your down payment. . In fact, maybe not even that slow .
It also goes without saying that you should not rely on this or any other article as financial advice – everyone’s situation is different, so talk to a financial advisor and let them help you. After all, there is no objectively “correct” decision about what to do with that large amount of money you were going to spend on buying a new house before the market hits you with a Mad Max . The bottom line is to make sure you think through all your options, make the calculations, and then make the decision that’s best for you.