Conventional wisdom suggests that if you have cash saved up and are looking to purchase a home, you should put that cash toward your down payment in order to reduce the size of your loan. But is that right?
Many traditional financial experts, such as Dave Ramsey, promote eliminating debt as the fastest and most secure way to financial freedom. After all, without debt, you are free to put your money to work however you want. However, a singular focus on avoiding debt at all costs may not be right for everyone, especially younger millennials who could benefit from getting into a house while also building their retirement portfolios.
When you look at your financial health as a whole, it may make more sense to consider both the short-term advantages of not paying down your loan (you keep your cash) and the long-term advantages of using the money in other ways (investing it to actually make more than you would save on interest).
There are several questions to consider when deciding what to do with “extra” cash if you are purchasing a home. At first glance, it might seem like the obvious answer is to pay down as much as you can from your mortgage. But first, ask yourself a few questions:
Can you make more money putting that asset elsewhere?
Kyle Tank, a financial advisor with Ameriprise Financial Services, Inc. in Troy, Michigan, says answering this question really depends on your situation. Compare how much money you will spend on interest over the lifetime of your loan (based on how quickly you plan to pay it off) with the average return rate of market investments.
Tank adds that there may be other financial advantages to carrying debt on your home, especially when you consider tax deductions and interest rates.
“Interest rates on mortgages tend to be more reasonable than on other types of credit and can potentially be deducted on your taxes,” Tank says. In other words, it’s better to take out a mortgage and have extra cash on hand than it is to put too much down on your house and end up carrying a balance on your credit card. Mortgage interest rates are significantly cheaper than credit card rates. In addition, a home is an asset that can grow in value, in addition to the tax advantages.
What kind of return could I make on my investment?
Here’s where being young has a great advantage. If you’re looking at buying a home as a millennial, not only will you have time to pay down your mortgage, but your home will also have plenty of time to grow in value. Concurrently, you’ll also be able to increase your wealth through your investment accounts.
Plus, if you put money in the market while you’re young, those investments have a lot of time to grow into a sizable nest egg. Another thing to consider: You won’t have to opt for as many high-risk stocks as an older investor since she has less time for her investments to grow.
“Millennials are in a great position to begin investing because they have time on their side,” Tank says. “The earlier you can start investing, the sooner you can begin taking advantage of compounding interest.”
For finance coach Juliana Valverde, there is little doubt about what route is best for a young millennial looking to start investing for retirement. She points out that the advantage of compound interest can’t be discounted and could very well outweigh any risks of carrying debt for the life of a mortgage.
“If you delay retirement investing until after you pay the mortgage, you’re losing valuable time that you won’t be able to make up — even with increased contributions to your retirement accounts,” she explains.
Despite the fact that millennials have time, investing doesn’t bring a guaranteed rate of return. As Tank points out, the return you make on your investments will depend on market conditions, your risk tolerance, and your financial situation. A 30-year-old couple living in the country with a couple of kids will have different needs and different results than a 30-year-old professional in the city who plans to remain single.
Are all your other ducks in a row?
Before you do anything else, make sure you have all of your ducks in row, advises Julie Ford, a certified financial planner and CPA with Ford Financial Solutions in New York City. If you have extra cash, Ford advises you to first make sure that all of your financial needs are met and priorities accounted for.
Ford’s recommended order of priority includes:
- Having an emergency fund of at least three months’ spending
- Eliminating credit card debt
- Tackling any other high-interest debt, like school loans
- Maxing out employer matches on retirement savings
- Contributing to your Roth IRA, if eligible, or maxing out other tax-deferred savings in 401(k), IRA, 529 college savings, etc.
From there, Ford notes that deciding on what to do with any excess cash flow depends on individual goals and tolerance for debt. “I often lean towards extra mortgage payments before saving into a joint brokerage account,” she says. “Even with a low-interest mortgage, paying down debt faster creates more opportunities and flexibility for clients. It’s a guaranteed return compared to unpredictable market returns.”
Can you split the difference?
If you’re still unsure, consider a compromise. Can you invest some of your cash flow and make a plan for extra payments on your loan? Can you use your savings to pad an emergency fund instead?
Depending on the type of mortgage you get, you may not have to put as much money down as you thought, and it may make sense to invest that surplus cash instead of automatically putting it toward your mortgage. Talk with a financial advisor who can help you figure out what kind of return you can expect on an investment, compared to what you would save on interest.
Options are always good, and in this case, having more options at your fingertips may just end up being more money in your pocket in the long run.