A Down
Payment on a Home is Not a Financial Cushion
(January 30th,
2008)
 In
an article by Marilyn
Kennedy posted on the Chicago Tribune, the author quotes,
Kibler
says he likes to see buyers put down at least 10 percent,
because they will have a cushion should home prices dip.
If you pay $300,000, for example, and need to move after
a year, you'll only have to pay off a $270,000 mortgage
balance. That gives you the freedom to sell for slightly
under what you paid for the house and pay a real estate
commission. |
I do not want to argue against a famous New
York city financial planner but contrary to his thoughts, the
10% down payment that people put down on their homes is NOT to
be treated as a cushion if home prices dip. That 10% x $30,0000
= $30,000 should be considered a potential capital loss! Here's
why:
i) If you sell your home for less than
what you paid for it, you have a capital loss, irrespective
of how much down payment you put on the house. Whether you financed
with a $0 down or a $50k down, you will have to eventually absorb
the loss. Two worst things could happen, you would lose all the
precious $50k cash that you put down on the house, or you would
have to absorb the loss by making payments on that $50k loan over
several years of time (the normal mortgage amortization schedule).
Why would anyone want to purchase a
home that could go down $30,000 in the next 1-2 years?
People should wait it out! It's better to buy at the bottom of
the real estate market crash, than to purchase in the middle and
take losses. With the Federal Funds rate expected to be lowered
up to 1% over the course of 2008, it makes sense to wait until
mortgages rates are lower, and when the US economy begins to recover
again.
The best way for home buyers to protect
themselves from falling real estate prices is to limit their investments
in it. This means you should not put down any more principal
(down payment) on your home than you absolutely have to. Say you
sell your home in 1 year from now for a $30,000 loss; two outcomes
occur.
i) You would have paid that $30,000
a year ago for the initial down payment, leaving you
with no cash in the bank.
ii) You would NOT have paid that $30,000
leaving you with that amount of money in the bank, which
could have earned you a decent 3% - 4% interest accumulating to
$30,000 x 4% = $1200
I'd rather take a gain of $1200 over
a year than a full blown out loss of $30,000 in that
year. What do you guys think? Post your comments & thoughts
below.
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