My wife and I have started to make plans for the upcoming move. We are still nine to ten months away from moving to the new city, but I want to be well prepared for the move. Hopefully this will be the last big move that we have to make and I want to make it as smooth as possible. Not only have I started researching moving costs, but I’ve also been looking into the cost of a condo in and around the new city.
My wife and I hate the idea of renting forever and we want to buy a place of our own. Originally, we thought that buying a place of our own would be more affordable in the new city, but we soon realized differently. Because we want to live close enough to downtown, it’s going to cost us a pretty penny.
While my wife and I recently started earning a little extra income, we’re far away from having enough for a 20% down payment. Since I want to buy our own place sooner rather than later, this means one thing: operation save down payment. Over the next 1-3 years, my wife and I will save all of our extra money so that we can buy a place of our own. We already make enough that we can afford the mortgage payment that it would be (with the down payment lowering the amount we would borrow), it’s just a matter of finding the money for the down payment.
How We Are Currently Using Our Extra Money
As I mentioned a couple months ago, my wife and I are directing almost all of our extra money towards retirement. We max out both of our Roth IRAs in addition to contributing a fairly aggressive amount to our 403(b) accounts. We know that this is important for us to set ourselves up for a bright future. We don’t want to be those who fail to save enough money for retirement.
Yet, with the new desire to save up a down payment, it leads me question which is better: Put all of our extra money towards a down payment so that we can buy a home 1-2 years sooner, OR continue to max out our Roth IRAs and delay our home purchase a few more years.
Is it Better to Invest for Retirement or Save for a Down Payment
Ultimately the question that I am asking is it better for young adults to save a down payment for a house or to invest for retirement. Which of the two should be the priority for young adults? While I understand that there are more than financial reasons for wanting to buy a home, I want to see which option is better according to the numbers. Before we jump to the calculations, let’s list the benefits of each option.
Advantages of Buying a Home Earlier
- 1-2 years of savings in rent – Since we are going to buy a home eventually, we’re going to pay off the mortgage for 30 years, regardless of when we buy. The earlier we buy, the earlier we stop paying rent.
- Lower Price – Assuming that the real estate market is back on the rise, which it seems that it is, buying a condo now could save us $10,000-20,000 depending on the rate of inflation. According to some research, home prices are expected to increase 3-5% in the area where we want to buy over the next year (but who knows how accurate those predictions are).
- Lower Interest Rate – Interest rates are at or near an all-time low right now. With the economy showing signs of recovering, it’s safe to assume that interest rates will rise over the next few years. No one knows if or how much interest rates will change, but even half of a percentage can make a huge difference.
Advantages of Maxing Out Roth IRAs & Delaying Home Purchase
- More Money for Retirement – Contributing to our Roth IRAs is something that we can only do this year. In other words, we can’t go back in time to contribute to our IRA’s since there is an annual contribution limit. In addition to this, saving money this early, with at least 30 years until retirement that $11,000 per year will grow to a sizable amount.
- More Financial Security – Another benefit of delaying our home purchase is that we will have a larger financial cushion to protect us from the worst case scenario.
Two Choices – Which One is Better?
As I have framed the dilemma, there are two main options. The first would be to continue our current commitment to saving for retirement by maxing out our Roth IRA and save any extra money towards the down payment. Following this path, I estimate it would take us 2-3 years from now to have enough money to buy a home. This seems like an eternity when I think about the idea of continuing to rent for this much longer, but it also means that our retirement accounts will be that much larger.
The alternative would be to cut all other savings down to the bare bones. Contribute in Mrs. 20’s 403(b) account up to the employer match and then put all of our savings toward a down payment for our home. This would expedite our savings and significantly reduce the time we have to wait to get into our own home.
For practical purposes, let’s assume that it shortened the waiting period by two years. Since my wife and I are currently paying approximately $16,000 per year in rent, buying a house sooner would save us approximately $32,000. In addition to this, a 5% increase in house prices over the two years would mean an increase of approximately $15,000. If there is an increase of .5% in the interest rate (4% to 4.5%), that would mean an additional cost of $17,000 in interest over the course of the 30 year loan. Here’s a look at the possible additional cost of waiting to buy a home:
- Rent: $32,000
- Inflation: $15,000
- Interest: $17,000
- Total: $64,000
Looking at how much we could save by buying a house right when we move sounds like a great plan until you consider what we are giving up. By sacrificing almost all of our retirement savings for 2 years, we would have approximately $22,000 less growing with compound interest for 29 years. In other words, we would have approximately $160,000 less 30 years from now (when we are close to retiring; assuming a 7% annual rate). Since this money would go into our Roth IRAs, it also means that we couldn’t play catch up like we could with paying off our future mortgage early. On top of having more retirement savings 30 years from now as a result of not sacrificing our retirement contributions, we would also have more money in our retirement funds at the time of buying our home to serve as a financial cushion.
When I compare the two options, I can easily see that sacrificing two years of retirement savings to save up a down payment faster is not the best option. If it comes down to sacrificing one year’s worth of Roth IRA contributions, I may be willing to do that, but only with the commitment that we would increase our 403(b) contributions after moving into the home. I’m not excited about renting for another couple years, but I don’t want to sacrifice financial security for the rest of my life only for the sake of buying a home 1-2 years earlier. After all, sometimes the best things in life are worth waiting for.
Readers, am I missing something in my cost comparison? Would you make a different decision?
We’d probably make the same decision that you did. But there is a 3rd option – that I mention only for the sake of being thorough. Have your cake and eat it too…
Basically buy now with a smaller downpayment, which would force you to take out PMI and pay for that until you’ve built up sufficient equity. Depending on PMI rates and quotes, that option might be reasonable, though it definitely involves more risk since the less equity you start with the easier it is to become underwater on a property.
Great point, as always Mrs. Pop. I haven’t closed the door on that option and that may allow me to save money on inflation and interest rates, but as you mentioned – it does come with additional risk. Considering that we don’t make the highest salaries, I think I would prefer to lessen the risk.
This is something that we are currently thinking about. Save for our next down payment or invest more heavily? It’s hard to decide!
Yeah, it’s definitely hard to decide. You want your money to be growing itself, but you also don’t want to risk the money that you need to buy the next house.
We have decided to save for a down payment instead of maxing out our retirement accounts. We are only going to do this for 2013. In 2014, we will readjust our contributions.
To us, it was a wiser decision to buy a house. We are still in our early 20s, make fairly decent amount of money, and can catch up with our retirement contributions. not to mention we are paying the same amount of money to rent an apartment as our mortgage plus property taxes plus insurance would be.
Thanks SavvyFinancialLatina. Everyone has a different perspective and I know that I may change my mind. But, when I know that I can’t go back and play catch up with the Roth IRA, I don’t know how to justify the loss of retirement income 30 years from now.
My wife and I have asked the same question recently. Since she has not purchased a home before, she’s able to withdraw $10000 from her 401k to put towards a home.
We’ve decided it’s worth it to get a lower interest rate and reduce the overall principle on the home. Our monthly payment will be lower because of the money down, so she will be contributing that extra amount to her Roth IRA each month.
Corey, bravo! You’re approaching this decision wisely – clearly defined alternatives, now you’re diligently evaluating the pros and cons with each, quantifying where you can – and even asking others what you might’ve missed. Your approach puts you way ahead of the game compared to most people.
It’s close – yes, you’re giving up $160K in your Roth. But house prices (usually!) appreciate, too, and the gain you’ll capture when you ultimately sell is excludable from your taxes, too. (The current limit on that is $500K for couples.)
The main difference is that your Roth portfolio is diversified and you’re unlikely to touch it until you’re much older – while a home is NOT diversified, and owning one *might* cause you to want to trade up every so often, with all the accompanying closing costs on both the buying and selling side.
So, I’d say – unless you’re really, really sure that you’d be staying put in your new home for quite a long time, play it safe and keep socking away shares into your Roth until you really are sure. Don’t let short term housing market dynamics affect a very big LONG term decision. (And WHATEVER you do, don’t pay less than 20% down!)
I say rent for at least six months in the new city to get an idea of the areas and where you really want to live. If you buy in the wrong place it will cost you a ton more than 6 months of rent.
I think if I were in your shoes I’d opt to do a combination of both. Continue saving some for retirement while at the same time saving for the downpayment, it might take a little longer to get the full 20% down, but at least you wouldn’t feel like you’re sacrificing your retirement in the long run.
Great article Corey. I ran into this question recently myself and we opted to save for a down payment. My feeling on this at the moment is that the stock market is up and real estate prices are down. I think we can take more advantage of the increase in real estate prices than stock prices.