Save for down payment vs borrow against equity?

Question

I have a two family house and the plan is to buy another one in 4-5 years. Keeping the current one, rent out both units, and move into the new one. We've been saving up for a down payment to do 20% down. Currently have about 40k in the bank and aiming to have 60k for a down payment with more left over.

My wife and I are currently not maximizing our Roth IRAs in order to save up. We're in our early 30s and putting in about 3k per year for each of us. If we double that to maximize contributions, we'd have that much less for the down payment in 5 years. We're currently saving maybe around 1k per month, but that may change. Current plans to buy a new (used) car later this year and also have another child, so she'll be out of work for a little while.

I could possibly borrow up to 30-50k or so against our home equity, most likely through refinancing our mortgage, which originated a few years ago at 4.25%. Would it be better to put more into our Roth's for retirement and borrow more for the down payment (either soon to take advantage of low rates or in a few years, closer to the next purchase) or continue saving and putting that into a HYSA, CD's, maybe a little investing?

Jerry Baldwin · Answer

Thank you everyone! So very helpful and thank you for the encouragement.

Jerry Baldwin · Answer

Yes, possibly a child in the next year or two. That 40k includes our emergency savings, so there's still a ways to go to have enough for the down payment plus emergency savings.

Mack Bekeza · Answer

@Jerry Baldwin, That's great to hear! It sounds like you and your wife have a solid plan in the works. As long as you map these goals on a timeline and stick to making progress with said goals, you two will be closer to achieving the ability to retire, or better yet, retire earlier than expected.

I liked what @Jaysen Medhurst wrote; those rental properties are an important component of your retirement plan. The cash flow and appreciation you could potentially gain can enable you to not entirely rely on Roth IRA withdrawals and social security for retirement income.

As long as you do not exceed the income thresholds from the IRS (currently $206,000 for those who are married and file jointly), you can make Roth IRA contributions to help generate tax-free income at any age. Also, you are not obligated to take required minimum distributions, unlike a Traditional IRA that requires those when you reach 72.

At the end of the day, people tend to invest in what they value. And if you believe Real Estate will bring you closer to your goals, as it has for many, I say go for it!

Jaysen Medhurst · Answer

The way I look at it, @Jerry Baldwin, the properties are part of your retirement plan. Why are you saving money in a Roth? So you can draw on it when you hit retirement. If you're using the money to purchase an asset that will create income in retirement without losing value when it does, that is the ideal retirement vehicle. Under a normal retirement situation, you're selling off assets (stocks, bonds, whatever) in order to fund the income you need in retirement. With investment properties, the income is generated by the asset without needing to sell it off. Most financial advisers recommend not drawing more than 4%/year from a retirement account. I expect any investment property worth owning to be cash flowing 2-4X that return.

Beyond that, over time any rental worth considering should be far outperforming the 6-7% you expect from your Roth. Hopefully, 3-4X the return when cash flow, appreciation, depreciation and mortgage pay down is considered.

Theresa Harris · Answer

@Jerry Baldwin  Do your employers match your retirement contributions?  If so, I would take advantage of that free money.

As for refinancing, you mentioned a lower rate and that you don't have PMI.  I would refinance (keep it low enough not to need PMI) and look for a good investment property.  Don't be in a rush to buy one, but if relying on your savings means waiting 4-5 years and you can lower the interest rate on your current mortgage, I would do that.

Mack Bekeza · Answer

@Jerry Baldwin, You are not looking at this the wrong way at all. Like what Jayson mentioned, it is vital to run the numbers on potential investments from all sides (potential cash flow/appreciation, financing, discussing tax consequences with a solid tax professional, etc.)

For clarification, are you and your wife expecting to have your second child within the next year or two?

Also, do you have any additional savings accounts allocated for things such as emergency expenses or other large purchases? Or is the account with ~$40k allocated solely for the down payment, and you wish to accumulate the $60K for the down payment and to have funds for emergencies and other large purchases?

Jerry Baldwin · Answer

Expanding on that, wouldn’t it be better to get a HELOC I could pay off in 10 years or less at say 4-5% and let the money stay in the Roth for another 25 years growing at 6-7%? Probably depends a lot on the exact rates and fees. Am I looking at it the wrong way?

Jerry Baldwin · Answer

Very interesting. I did not consider withdrawing Roth IRA contributions. Why do you recommend this over a HELOC? I would still be about 25 years away from retirement at that point. It doesn't sound ideal to me as I would think it's best not to touch retirement funds, but maybe I'm wrong. I wouldn't be able to put that money back into the Roth eventually in addition to the the max I would be putting in every year, so my total at retirement would be down. Is that still worth it compared to paying interest on a loan (HELOC)? I guess maxing the Roth and taking the contributions out in 5 years would definitely be better than just saving that money now. That part definitely makes sense to me, but I need to look into that more vs a HELOC.

Jaysen Medhurst · Answer

@Jerry Baldwin, a few points of clarification:

• Your property taxes are going to go up if you've created value. Even if that's in a few years when the town reassesses everything. I wouldn't wait to refi/HELOC based on that. Of course, you could just check with the town to confirm if either of those things would trigger a re-appraisal by the town.
• It's probably not worth it to refi for just a 100 basis point reduction in your interest rate. You'll save about $684/year/$100k you owe. So if you owe $200k and expect to pay $4k in closing costs, it will take about 3 years to break even.
• A HELOC does require an appraisal (not an assessment), but often times they are very cursory. Not the full appraisal, like when you buy a place or do a refi. This varies by lender.

Getting to your question: it's probably best to max out your Roth IRA and then withdraw (contributions only) for the future down payment. The Roth will grow tax free and there's no penalty for pulling out contributions. If you put the same amount of money in an investment account and get the exact same return, you'll owe CG taxes when you withdraw. This gets very complicated, very quickly depending on many of the details of your individual situation. Please take this with a grain of salt and make sure you have a conversation with a good CPA.

Jerry Baldwin · Answer

Thank you very much. I kind of expected to be asked for more info. I know there is a lot going on and there are a lot of considerations. One clarification for something I didn't explain very well is that the house we plan to purchase in a few years will most likely be a single family home for my family, unless we get very lucky and find a two family home that has a small apartment we can rent out. So then our current two family house will turn into a full rental property (currently renting out one unit and living in the other).

I have been thinking about refinancing in order to lower our interest from 4.25%. I assume rates might still be going down a tiny bit for another year or so, but who knows where it'll be in 4-5 years. We don't have PMI on our mortgage. So you're saying probably not worth it for a 1% decrease. That's helpful thank you. I have been learning a little bit about HELOC recently. One more thing that would be a reason for me not to refinance too soon is that the value of our house has increased possibly significantly since we bought it. After reassessment, our taxes might go up. Did a major gut renovation of the entire house when we bought it. We purchased it at $150k and it might be now $200-225k (probably higher if it was in a nicer area). Is an assessment involved with getting a HELOC? It would be nice to avoid the major jump in property taxes.

Going back to my original question. Would it be more worth it to get a HELOC in a few years to help with the down payment (maybe 20-40k) and put more money into our Roth IRA's now for retirement or save up more now to not borrow any money for the down payment?

Save for down payment vs borrow against equity?

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