Edward is about to become a first time home-buyer and is trying to be as prepared as possible to make all the right decisions. When Edward isn’t busy learning his craft and working toward his financial goals, he writes about cooking for beginners at If You Can Read, You Can Cook.
My wife and I are planning on buying our first home next year, so home buying and mortgages are topics on which I have been soaking up information. I’ve been talking to everyone from bankers to bloggers, reading advice from debt gurus like Dave Ramsey, and soaking up every word that M.D. has written on the topic. Then when while I was partaking in one of my favorite pastimes (mental arithmetic, don’t laugh) at work, I came to a startling conclusion.
Buying a home with a mortgage COULD save you thousands of dollars.
Dave Ramsey believes that you should never take on additional debt and should rent until you can save the entire home price. He calls this the 100 down plan. On his website, he uses the example of saving $30,000 per year and buying a $100,000 starter house. The problem is that the US median household income is less than $50,000. The average family won’t be able to save anywhere near that much money.
I’ll start with the regular disclaimers. This plan only works if you plan on living in the same place for a while. Don’t buy if you aren’t psychologically ready for the commitment of undertaking such a large financial commitment or being your own landlord. This idea may not be the best one for you and your situation; sit down and do the math yourself for your own situation.
And one final disclaimer. I’ve only done the math for my situation: living in an area with a relatively high rent to home price ratio. In the college town that I live in, students increase the population by almost 20% during the school year. That puts a high demand on rental units in a part of the country with relatively low house prices.
So right now, we are paying $750/month rent and are looking at $200,000 houses. We are saving $1000/month towards a down payment after starting out from no savings a few months ago. I am assuming a 5% mortgage interest rate and 1% savings interest rate. I calculated three scenarios:
The Dave Ramsey 100% down payment plan
To save $200,000 at the rate of $1000 per month, it will take 15 years. During this time, you will pay $135,000 in rent. Of course, this is assuming that home prices, rent, and income don’t increase in 15 years. And chances are that income isn’t going to increase as quickly as home prices or rents.
So the house price is really $335,000.
The standard 20% down payment
The standard advice is to save a 20% down payment and get a mortgage for the remaining 80%.
To save 20%, it will take just over 3 years to reach $40,000. During this time, you paid $27,000 in rent. Once you buy, you can use your old $750 rent payment and your $1000 savings to pay a mortgage payment of $1750. It will take just under 10 years to pay off the mortgage and you will pay $42,000 in interest.
Grand total: $269,000.
At the end of the day, simply having a mortgage saves tens of thousands of dollars over paying cash. You can also apply this theory for buying a run down home as a young investor.