Apart of me wishes I could see how much money I've spent total at Dunkin' Donuts… Gotta be at least a down payment on a house
— Jackie Archambault (@jackiearch) June 22, 2017
Really Down Payment is very important in many deals which are expensive. Like Car, House ( May be there is down payment in deals while buying companies, islands, some large land parcels. But as I am not Billionaire, so I don’t know. If any billionaire is reading this, pls comment)
Jokes apart, what is down payment? and why you need to make provision or think about it?
as per Investopedia Down payment is
Down payment is type of payment made generally in cash during the onset of the purchase of an expensive good or service. Generally it is part of the total price. sometimes it is not refundable even if the deal fails to takes place. In most cases, Purchaser made financing arrangement for remaining amount.
— SBSavings (@SBSavings) June 25, 2017
Why I am writing a post on this topic on website for investors? Down payment is more or less like premium on future Contracts of Stocks. some characteristics are same. Some are little different.
Size of down payment talks many things about deal and the risk attached in it. If you are in US and planning to buy house, its not always 20% in fact Mortgages backed by USDA and VA don’t have any down payment. FHA backed mortgages need only 3.5%. First time buyers received big help even if you are in conventional mortgages. Here in India, Nowadays as govt is helping people to buy house, getting 90% mortgage isn’t dream. But that does not mean you only supposed to pay only the amount equal to down payment. Here I am going to explain how.
Lets take one example. While writing this average price of New House deal in US is $406400 (Jan 2017). While writing this post, 15 year fixed mortgage interest rate is 3.02% and 30 years fixed mortgage is 3.80%.
Option 1. Paid 3.5% Down payment on $406400 by taking 15 years Fixed mortgage.
Down payment $14,224. Finance received $392,176. 180 installments of $2712.0. Interest paid in all this installments is $95996.48 . $43627 is the salary. Down payment is around 33% of salary. Installments are 4% of salary.
Option 2. Paid 5% Down payment on $406400 by taking 30 years Fixed mortgage.
Down payment $20320. Finance received $386080. 180 installments of $2670 . Interest paid in all this installments is $94504.3 Other Details remain same. The reason to take 5% down payment is it is nearly half of salary. In India bankers generally try to keep installments under 50% of salary. Yes, India and US is different but still I am taking some assumption here. 30 year Fixed mortgage may look difficult in US as job security and other things don’t support that’s why I am taking it as 15 years Fixed mortgage. US govt jobs can give you such job security for 30 years but not everyone having that.
One thing is clear here. By paying $6096 more in upfront, You are paying less $42 per month. It also save $1492. More the interest rate, more the difference. Longer the time, more interest expenditure.
Why I was doing all this calculation? though, the percentage of down payment to salary is low here in example, it may look bigger in real life. In fact it looks difficult to pay half of your salary as down payment. In some case it maybe bigger than salary also as the salary maybe dominated by IT and Wall street people. who knows?
So the main question here is how to raise such large amount?
Lets check it out.
First, Decide when you are planing to buy home. When I was doing research for my blog post When should you buy house, many advisors told me the age to buy new house is 35 years. Up-to 30 years generally the expenditure is very high. I know that in US, many youngster start their job at around 16-18 ( Forgive me if I am wrong) and many of them are not living with their parents, which is reality in India. but for buying home, which if I am not wrong having minimum cost is $150,000 for basic amenities ( again, forgive me if I am wrong) and the 3.5% down payment is coming to $5250. By assuming that you supposed to have twice salary you need to keep it at $10500. Now if you remove effect of IT and other top paid peoples, this amount looks possible when you have college education or having some luck for keeping you in long term for some good gain of experience. for giving it to next more than 10 years. In any situation, I don’t think that this will take place under 22 years. Lets make it 25. so you have 10 years to start investing for down payment. Though early years it will hardly large amount. but still assume that you started saving and investing at 25.
Next, Take effect of inflation into account. What will be trend of inflation for next 10 years. Getting this number is little difficult as this holds some guess work. But still, as you are living there, you can guess. As per US Labor Department, inflation in US ended in May 2017 was 1.9%. But in 2016 it was 2.1%. so lets assume that inflation will be 3% average ( Yes. Its high. but its good to be ready for worst.) So for today’s $20320 will be $27418 after 10 years when you will be 35.
Third step. for achieving this $27418 in 10 years what is your per month investing and at what rate? as the Time frame is long term, you can invest in equity. Though I don’t Prefer to invest in Index Funds, But as the efficiency of US is high and so its impossible to go anywhere, Its vanguard. last 5 years it gives you 13.30%. Assuming you will get same return, the amount you need to invest per month is $110.36 assuming monthly compounding.
Defense rest. For buying house after 10 years, if you started from today you need to invest only $110.36 per month which will cover large size of down payment with some assumptions, many of them taking care of worst case scenario.
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