First off, thank you for the podcast. I listen to each episode and I appreciate that you make personal finance entertaining! My wife and I live in the Midwest and just welcomed our first child a few months ago. We live in a starter home that works well for us right now but we fully expect to outgrow the house in the next 3-5 years as we continue to grow our family. My question is about what to do with the nest egg that we’ve saved for our next home. We currently have $86K left on our mortgage and we’ve saved $67K for our next home in an online savings account. Should that $67K stay in the online savings account or would it be more beneficial to pay down our current mortgage and decrease the interest payments? My thoughts on keeping that money in the savings account are that it shouldn’t be invested because we’ll want to use it in the next 3-5 years. I also think it’s more beneficial to have the money liquid to use for the down payment on our next home rather than have all our equity tied up in our current home. It has always nagged me that maybe we should put that money towards paying down our current mortgage. What do you think? Is it better to pay down our mortgage and have all our money tied up in the equity of our current home OR should it stay liquid in an online saving account so it’s ready to be used as a down payment for our next home? The interest on the online savings account is 2.00% APY and the interest on our mortgage is 3.85% fixed. We have no other debt, we have a six-month emergency fund, and we’re saving well for retirement so the money is truly meant to be used for our home. Please let me know if I should provide any additional information. Thanks again!
Thanks for your question, Matt. And, thanks for being a regular listener to the podcast. If you haven’t checked out our private group on Facebook, The RePeters, look us up and join (this goes for the rest of you, too). I think you might enjoy it!
Let me congratulate you on the work you’ve done saving for your future. You will, without a doubt, be better off for your efforts when the time comes to upgrade to a bigger house. The question you raise, however, is a good one. If I’m being honest, these types of questions are some of my favorite to answer.
Currently, you’ve got your savings set aside in an online saving account earning a robust (comparatively speaking) 2%. The interest you’re paying on your home is near twice that, but still very reasonable at 3.85%. Should you risk tying up too much money by using your funds to pay down the house in order to save a little bit of cash? If I was in your shoes, this is the approach I’d consider taking:
Start determining the price range of the next home you want to purchase. How much should that be? We suggest keeping your housing expenses right around 25% of your take-home pay each month (unless you live on a coast where housing costs are considerably greater). You’ll probably have to do some calculating as to how a monthly payment translates to the purchase price of the home, but there are a number of online calculators that can help you do this pretty easily. By the way, don’t be swayed when a bank or other lender tells you that you qualify for a way bigger mortgage than what we recommend. The focus of banks (especially large national ones) has largely turned to encourage you to spend money instead of saving it. Banks want to make money and that often means offering people loans that they can’t reasonably afford. Don’t fall for it.
With that PSA out of the way, here’s where you start to make money moves.
Once you determine the price you want to pay for the future house, calculate what 20% of that number is in order to come up with your target down payment. Does your current future home savings account cover that amount of money? If so, great! We’ll move on to step two shortly. If it doesn’t, keep plugging away. When you get there, move on to the next step.
In this step, you will subtract the calculated down payment from the balance of your savings account and then apply the difference to your current mortgage. This will accomplish two things for you.
- You’re all set with your 20% down payment just waiting to be deployed when the right house comes along. You’ll have flexibility by being able to move on a house quickly if you need to, even if your current home hasn’t sold quite yet, because you didn’t tie everything up in the principal of your home. Offers contingent on the buyer’s home selling stink for both the buyer and seller. If you’re prepared to buy before you even walk through the house the first time, you’ll already have an advantage over many other buyers.
- Obviously, you’ll save some interest on your current mortgage with the additional principal payment and build equity even faster with each monthly payment.
With this approach, you’ll be prepared for the future while making a dent in your current mortgage, as well. That’s killing two birds with one stone (sorry about the birds).
Finally, once you’ve bought a new house and sold your current home, you’ll be able to take the equity you had in your current home and put it towards the new mortgage, address any remodeling/upgrades/repairs, give a boost to college savings for your kids, a combination of any of these, or something entirely different. Regardless, you’ll be in great shape to make a number of positive financial moves.
Damian is the lead Financial Concierge on Your Money Line, the financial help line serving all Pete the Planner® Financial Wellness clients. Damian is a CERTIFIED FINANCIAL PLANNER™ professional and loves answering your money questions. Despite sharing a last name and sense of humor, Damian and Pete are not related.