Buying a house, crunching numbers, and saving on taxes

[Greg]

Greetings all. I've buying a house in the next few weeks and being an analytical person to a fault I've been trying to answer a lot of questions:

1.) Opportunity Cost, how much is worthwhile to put down for a down-payment?
2.) Is it better to get a 15 year or a 30 year mortgage?
3.) Who to get for a mortgage lender?
4.) Mortgage Credit Certificates - Great if you can get them
5.) Creating a business and how best to take a deduction for the house to get the maximum deduction possible
6.) And more! (other ways to save money once you own a home)

I started digging around on the forum and found some interesting nuggets of wisdom but wanting to bring some of it to here as well.

1.) Opportunity Cost ( I really liked these links)
- http://www.investmentzen.com/blog/shoul ... or-invest/ (Monetary policy makes the interest rates very low which makes a 30 year mortgage a "gift". You should put down as little as possible and stretch out paying it off for as long as possible)
- http://www.heracliteanriver.com/?p=478 (how inflation eats away at the “cost” of the mortgage)
2.) 15 or 30 year mortgage? (also looking above towards inflation)
- https://docs.zoho.com/sheet/published.d ... 80a6686d21 (chart for looking at the opportunity cost of getting a 15 year mortgage or getting a 30 year mortgage and investing the difference)

I don't have a Tyler Portfoliocharts-version yet for this (I just did plug-and-chug on excel for all of my data, see below), but it gave me good confidence in what I'm doing. I'll be doing a 5% down payment on a house



This chart above showed the savings of going with 5% down versus 20% down in today’s dollars, what the inflation rate is over the life of the loan on average, and what the nominal CAGR returns are over the life of the loan (30 year mortgage). This was for a 3.74% 5% down payment loan of $285k compared with a 3.865% 20% down payment loan of $240k (this is on a $300k house) (also note that there at the time was a difference in the interest rate of if you’d want a 5% down or a 20% down payment). What this chart shows is that you make more money with a higher return, and make a bit less money with more inflation (while this is obvious, it’s nice looking at it from a probability standpoint to say a lot of these combinations above are “positive” values after 30 years (positive again meaning you MAKE money putting down only 5% instead of 20% down payment). I also had a highlighted section showing the line of 3% real-returns which is common for a permanent portfolio return (nominal minus inflation).

3.) Mortgage Lenders - I'm using Sebonic Financial for my mortgage lender since they were the cheapest on Bankrate at the time. Sebonic has been great thus far although one of their associates described themselves as this and I agree with them: They said that you can go to Macy’s and have someone walk you totally through a purchase and they are there to answer every one of your questions. Sebonic isn’t like that, they are more of the type of people that would shop around online, read reviews to get sufficiently knowledgeable about what you’re getting, and then buying it on Amazon for cheaper than at Macy’s. Sebonic makes their money on volume of mortgages made and not on each individual mortgage so they just don’t have a ton of time to continually answer their client’s questions. Their business practices suit my personality.
4.) Mortgage Credit Certificates – super way to get tax credits for the interest you pay but there are a lot of strings attached to it and every state is different. I make too much for Mortgage Credit Certificates but man would that be sweet if you lived in an area where you didn’t need it to be your first-home to get the tax credits for the rest of the time you live there paying mortgage interest.
5.) Small-business, I’m thinking about making a board game hah (plus if I can get a tax deduction, even better :-D)

[WiseOne]

Good to hear from you Greg! Congrats on buying a house.

Some mortgage advice. If you anticipate a very simple situation and you've got a local bank offering a good deal, go directly to the bank. Otherwise, there are advantages to going with a mortgage broker, as they have some leverage with the banks that you don't have. On my recent purchase, I ended up running over the lock period because of various coop-related delays. If I had gone directly to Wells Fargo, that would have cost me thousands but the broker was able to limit the fees to $500.

One huge disadvantage of a broker is that they hold your loan initially and then sell it to a bank/servicer. I made VERY sure that my loan was going to Wells Fargo to be serviced by them. Otherwise, you could end up with a loan serviced by Ocwen, which I regard as a purely criminal organization. Avoid at all costs!!!

[Mountaineer]

A soft consideration: Early in my career, I crunched numbers to make the decision and made the assumption (which turned out to be correct) that my salary would continue to increase throughout my working years. After I retired (which usually means relatively fixed income) my main consideration was not mortgage rates or expected inflation or appreciation of the home, but peace of mind for myself and my wife; thus I chose to have no mortgage hanging over our heads - especially significant if I die before my wife who has little interest in things financial. I also thought that there is no use paying interest to someone for a home (or vehicle) when the income is fixed. My two cents.

[Greg]

Good stuff, Greg! And welcome back, I've always liked your posts.

Glad to be back. I've just been a lurker for a little whiles due to other things I've been paying attention to instead.

In my experience, the one factor in house purchases that overwhelms all others is appreciation. I know your post isn't about that, but after 5-10 years it will be more important than any of the other factors. Unfortunately, like most other events in the future, it's totally unpredictable.

True, but if you're not intending on selling the house, there's not really as much interested in appreciation/depreciation (huge assumption but still). Personally if I'd never sell the house, I'd be fine with it just staying the same price over time, would keep my property taxes lower.

Your approach to the mortgage should probably depend on many factors that are unique to each person. The most important issue is liquidity ... if you skew toward a shorter mortgage, either by going with a shorter term, putting more down, or making extra principal payments, you're effectively trading liquidity for reduced interest expense. I always opted for this path. I figured that if I got laid off or fired, I'd land on my feet and not be killed by lack of available cash. But it depends a bit on your career and risk tolerance, along with family obligations, etc.

That’s true, I’ve got a federal government job though. Short of murdering someone at my job, there’s very little chance I could get fully fired versus just being moved somewhere else in the country.

Another factor that's somewhat philosophical is the fact that debt approximates a negative bond allocation ... if you're routing more money into investments rather than paying down the mortgage, you're effectively borrowing to finance investing. And if a portion of that investment is bonds, it would make sense to only do that if the bond yield is greater than the mortgage rate.

Yep, borrowing to invest is correct (but not as bad due to the not being a callable-bond and interest deductions). And bond yield would only be a component of it if you’re also considering: mortgage interest deduction, price appreciation of falling interest rates over time, and the context of overall Permanent Portfolio yield which was historically 3-6% real. A mortgage at 4% which pays $10,000 in interest in the 25% tax bracket is $2,500 less in taxes, or only a 3% mortgage rate equivalency. With a 2% inflation, that’s only a 1% mortgage rate equivalency in real terms (as in I only need to make 1% real to break-even). At least if my thought process is correctly, I think through investing I have a decent chance of consistently getting higher than 1% real.

[Greg]

Good to hear from you Greg! Congrats on buying a house.

Some mortgage advice. If you anticipate a very simple situation and you've got a local bank offering a good deal, go directly to the bank. Otherwise, there are advantages to going with a mortgage broker, as they have some leverage with the banks that you don't have. On my recent purchase, I ended up running over the lock period because of various coop-related delays. If I had gone directly to Wells Fargo, that would have cost me thousands but the broker was able to limit the fees to $500.

One huge disadvantage of a broker is that they hold your loan initially and then sell it to a bank/servicer. I made VERY sure that my loan was going to Wells Fargo to be serviced by them. Otherwise, you could end up with a loan serviced by Ocwen, which I regard as a purely criminal organization. Avoid at all costs!!!

I'll have to look into that for selling my loan to someone else. Thanks for the tip.

Also Sebonic at the time provided a 3.74% interest rate with $0 fees for a 45-day lock. I checked with some local banks and they were all higher rates or had more fees, (at the time, and obviously things can fluctuate over time).

[Greg]

A soft consideration: Early in my career, I crunched numbers to make the decision and made the assumption (which turned out to be correct) that my salary would continue to increase throughout my working years. After I retired (which usually means relatively fixed income) my main consideration was not mortgage rates or expected inflation or appreciation of the home, but peace of mind for myself and my wife; thus I chose to have no mortgage hanging over our heads - especially significant if I die before my wife who has little interest in things financial. I also thought that there is no use paying interest to someone for a home (or vehicle) when the income is fixed. My two cents.

Couldn't you just have a life insurance policy that would pay off the mortgage in case of death? I would think that'd be a lot cheaper than paying off a mortgage early with more-expensive "present" dollars versus less-expensive "future" dollars.

And if your income was fixed, couldn't you still make more by investing that money instead in the hopes of beating inflation versus paying off interest? I would think this is the same argument as you had before, just that in one case your income is fixed, and an income that might index to inflation over time (or just grow in general due to being awesome at your job).

[Mountaineer]

A soft consideration: Early in my career, I crunched numbers to make the decision and made the assumption (which turned out to be correct) that my salary would continue to increase throughout my working years. After I retired (which usually means relatively fixed income) my main consideration was not mortgage rates or expected inflation or appreciation of the home, but peace of mind for myself and my wife; thus I chose to have no mortgage hanging over our heads - especially significant if I die before my wife who has little interest in things financial. I also thought that there is no use paying interest to someone for a home (or vehicle) when the income is fixed. My two cents.

Couldn't you just have a life insurance policy that would pay off the mortgage in case of death? I would think that'd be a lot cheaper than paying off a mortgage early with more-expensive "present" dollars versus less-expensive "future" dollars.

And if your income was fixed, couldn't you still make more by investing that money instead in the hopes of beating inflation versus paying off interest? I would think this is the same argument as you had before, just that in one case your income is fixed, and an income that might index to inflation over time (or just grow in general due to be awesome at your job).

Greg,

Your points are good ones that I used to pursue myself. Probably the easiest way to convey my thinking is that I switched from a mindset of "more is better" to a mindset of "enough is enough". I used to save every dollar I could, minimize eating out, minimize extravent vacations and the like. I tried to invest in ways to squeeze out every last potential penny. After several decades I came to realize that after a career of hard work, great salary, and frugal living there was far more to life than crunching numbers and maximizing net worth. "Enough" is a freeing mindset. It frees one to enjoy life, enjoy experiences, help others who are in need, and give thanks for all the gifts I've been given (gifts in the sense of peace, prosperity, friendships, and understanding what is truly important - as well as material gifts). Enough soapboxing, I've been where you are and would likely do it again the same way if I were a youngster like you. My very best wishes to you for a fruitful career and life. Growing older has its benefits as well as hardships. It's hard to explain.

... Mountaineer

[jhogue]

Greg,

1. You said you were going with 5% down and a 30 year mortgage. Most mortgage lenders require private mortgage insurance if you put down less than 20%. Did you account for that ?

2. I second Desert's view on the importance of liquidity, especially for a first time homeowner.

[Greg]

Greg,

1. You said you were going with 5% down and a 30 year mortgage. Most mortgage lenders require private mortgage insurance if you put down less than 20%. Did you account for that ?

2. I second Desert's view on the importance of liquidity, especially for a first time homeowner.

I did factor in PMI (also historically in the past, PMI was tax-deductible, we'll see if this occurs in the future or not). Regardless, it raises the rate by a bit, however this can also be counterbalanced by what seems is the more you borrow, the lower your rate goes. So it was seeming when I was checking almost a wash percentage-wise between putting 5% down ($285k loan) with PMI or 20% down ($240k loan). I still then favored the 5% down due to additional liquidity and the hope that I can get a higher rate of return than just sinking my money into the house where I can't then touch it outside of a HELOC, etc.

[Greg]

Another factor that's somewhat philosophical is the fact that debt approximates a negative bond allocation ... if you're routing more money into investments rather than paying down the mortgage, you're effectively borrowing to finance investing. And if a portion of that investment is bonds, it would make sense to only do that if the bond yield is greater than the mortgage rate.

Yep, borrowing to invest is correct (but not as bad due to the not being a callable-bond and interest deductions). And bond yield would only be a component of it if you’re also considering: mortgage interest deduction, price appreciation of falling interest rates over time, and the context of overall Permanent Portfolio yield which was historically 3-6% real. A mortgage at 4% which pays $10,000 in interest in the 25% tax bracket is $2,500 less in taxes, or only a 3% mortgage rate equivalency. With a 2% inflation, that’s only a 1% mortgage rate equivalency in real terms (as in I only need to make 1% real to break-even). At least if my thought process is correctly, I think through investing I have a decent chance of consistently getting higher than 1% real.

I see your points and don't entirely disagree, but here are a couple of additional factors to consider:
1. Mortgage interest is deductible, but taxpayers rarely are able to deduct the full amount. If you itemize today, exceeding the standard deduction without mortgage interest (for example, charitable contributions), then the full amount of mortgage interest and property tax will be deductible. But that's fairly rare. Most homeowners are not able to effectively deduct the entire annual interest and tax amount.

2. Comparing the risk-free return of pre-paying a mortgage with the expected return of the HBPP is not the ideal comparison. I would compare the after-tax mortgage rate with the bond portion of the HBPP. Short treasuries and long treasuries in a barbell allocation yield something around 2% right now. Unless your after-tax mortgage rates is lower than that, you're essentially borrowing money to invest at a lower rate. This may be the right thing to do for liquidity, but it should be looked at realistically.

Your points are valid Desert. Luckily (or unluckily), I live in the higher-tax state of Maryland so it is easier to reach the mortgage interest almost entirely overtop of the standard deduction amount just with state, local, and property taxes.

Agreed that risk-free returns are valid against bonds solely, we've always talked on here of trying to not look at single assets in a vacuum but all of them coupled together. I figure that I have a better chance of making more with investing over the long term versus paying off my mortgage early but that's just the risky kind of guy I am (like riding a bicycle without a helmet sometimes, oh yes, I am a daredevil).

[jhogue]

Greg,

1. You said you were going with 5% down and a 30 year mortgage. Most mortgage lenders require private mortgage insurance if you put down less than 20%. Did you account for that ?

2. I second Desert's view on the importance of liquidity, especially for a first time homeowner.

I did factor in PMI (also historically in the past, PMI was tax-deductible, we'll see if this occurs in the future or not). Regardless, it raises the rate by a bit, however this can also be counterbalanced by what seems is the more you borrow, the lower your rate goes. So it was seeming when I was checking almost a wash percentage-wise between putting 5% down ($285k loan) with PMI or 20% down ($240k loan). I still then favored the 5% down due to additional liquidity and the hope that I can get a higher rate of return than just sinking my money into the house where I can't then touch it outside of a HELOC, etc.

Greg,

Make sure that your mortgage provides, in writing, that your PMI can and will be dropped once your equity reaches the 20% level.

Since you mentioned that you are a federal employee, I assume that you are eligible for the Thrift Savings Plan. The TSP G fund is a Treasury- issued security with some of the features of US savings bonds. It currently earns 2.25%, tax deferred, vs. 1.96 for I bonds. Since you described your work situation as ultra-stable, you might consider constructing the cash portion of your PP as a series of buckets to be filled from left to right as follows:

Treasury Money Market Fund/ I bonds/ G Fund/ EE bonds.

Once you have sufficient day-to-day liquidity in your TMMF and an emergency fund in I-bonds, you might split future cash contribution between I bonds/G Fund as your deep cash with EE bonds as deeper cash. Of course, the precise details would depend on your personal situation.

[Greg]

Greg,

Make sure that your mortgage provides, in writing, that your PMI can and will be dropped once your equity reaches the 20% level.

Since you mentioned that you are a federal employee, I assume that you are eligible for the Thrift Savings Plan. The TSP G fund is a Treasury- issued security with some of the features of US savings bonds. It currently earns 2.25%, tax deferred, vs. 1.96 for I bonds. Since you described your work situation as ultra-stable, you might consider constructing the cash portion of your PP as a series of buckets to be filled from left to right as follows:

Treasury Money Market Fund/ I bonds/ G Fund/ EE bonds.

Once you have sufficient day-to-day liquidity in your TMMF and an emergency fund in I-bonds, you might split future cash contribution between I bonds/G Fund as your deep cash with EE bonds as deeper cash. Of course, the precise details would depend on your personal situation.

Thanks jhogue (I keep looking at your name and wanting to call you hoagie, but I'll attempt to refrain).

Agreed I'll need to verify about the PMI to get it out. After I finalize my mortgage, I'll be slowly moving money around to emulate the Golden Butterfly portfolio and appreciate your thoughts on the "cash" component. Thanks!

[WiseOne]

Simplicity in number of accounts, debts, etc. become increasingly important as we get older.

+1. Aging makes it harder to manage a lot of scattered accounts, and that's important to keep in mind when you make long term investment plans. Not to mention what might happen if a relative had to take over all your financial responsibilities.

[jhogue]

Greg,

Make sure that your mortgage provides, in writing, that your PMI can and will be dropped once your equity reaches the 20% level.

Since you mentioned that you are a federal employee, I assume that you are eligible for the Thrift Savings Plan. The TSP G fund is a Treasury- issued security with some of the features of US savings bonds. It currently earns 2.25%, tax deferred, vs. 1.96 for I bonds. Since you described your work situation as ultra-stable, you might consider constructing the cash portion of your PP as a series of buckets to be filled from left to right as follows:

Treasury Money Market Fund/ I bonds/ G Fund/ EE bonds.

Once you have sufficient day-to-day liquidity in your TMMF and an emergency fund in I-bonds, you might split future cash contribution between I bonds/G Fund as your deep cash with EE bonds as deeper cash. Of course, the precise details would depend on your personal situation.

Thanks jhogue (I keep looking at your name and wanting to call you hoagie, but I'll attempt to refrain).

Agreed I'll need to verify about the PMI to get it out. After I finalize my mortgage, I'll be slowly moving money around to emulate the Golden Butterfly portfolio and appreciate your thoughts on the "cash" component. Thanks!

Greg,
I have been called a lot worse things than “hoagie.” Students in my college freshman history lecture employed a number of colorful epithets to describe me after I returned their first exams.

Good luck with the house. I think you have done your homework on the mortgage.

Because of the size of a mortgage in relationship to their overall net worth, most people find that it takes them a while to “re-discover” their optimal liquidity preference. My experience is that it was much better to overestimate my need for liquidity rather than underestimate it.