Buy Now vs. Wait: Some Practical Hypotheticals

I am hoping to buy in the (city) area and am reviewing the possibilities. While I fear that the local market may be peaking, I intend to live in the home for at least ten years, so I am not trying to time the market.

My questions have to do with the down payment. I expect to shop for a property in the $450,000 range, and currently have $60,000 available for a down payment. I make a decent salary and receive an annual bonus of $35,000 - $40,000 each February. The bonus, while not guaranteed, is very dependable. After taxes and deductions, I should realize about $20,000 - $25,000 from it.

Do you think I would be wise to wait until February, by which time I will be able to make a down payment of $90,000 and perhaps avoid PMI and pay less interest over the life of the loan, or seek to buy now and lessen the taxes on the bonus? (I itemize, am single and am in the 28% bracket). Will the greater down payment help me to capture a better interest rate on the loan? (My credit scores are right around 800). Also, if I buy now, is it possible that I will be able to negotiate a mortgage in such a way that I can pay my realized bonus in February as a lump sum towards the remaining principal without incurring penalties? Ideally, i would like to use my bonus each year to pay down principal, as I can afford to balance my budget, including regular mortgage payments, without touching the bonus.

While on the subject of credit scores, I am reminded of another question - does an 800 score do me any good as contrasted with, a 740 or 750? Thank you again for your consideration. Your writings have been invaluable to my education.

I needed some more information, so got a subsequent email

I would expect the property taxes to run about $5,000 annually and association dues to be another $350 monthly. As I don't have a car, parking fees will be inapplicable. My closing costs should be somewhat reduced as I work for a bank (parent company) and they offer employees favorable mortgage rates with no points and no origination fees. Of course if I go elsewhere for the loan that would not apply, but I would only expect to do so if I received even more favorable terms.

As for an equivalent property, the market would price the rent at about $2,200 a month, although I am only paying $1,520 now (for a less desirable place than what I am shopping for).

First things first. You are easily A paper. Some lenders might have a small incentive (no more than 1/4 of a discount point) for folks with credit scores over 760, but most don't, and even if you go looking for one that does, it's no guarantee that their overall rate will be better than what you could get elsewhere. Remember, it's not important that they give you a quarter point incentive if their trade-offs were more than that above the competition. Look for a loan based upon the bottom line to you, not a little tweak that says you get treated a little better than the next guy.

Second, split your loan into two pieces to avoid PMI. One first loan for 80% of the value, and a second for the remainder, whatever that is. The second will be at a higher rate, but better that than paying PMI on the whole balance. It's likely to save you a lot of money this way. If you intend to pay it down, be very certain that there will be no prepayment penalty.

Now, let's look at now versus basically a year from now (Since February is ten months away). One thing I'm going to look at is whether your location may be above sustainable levels. My rule of thumb is that if a 20% down payment won't break even on rental cashflow, your area is likely to be overpriced. With current rates (6.25% for a thirty year fixed rate loan at par for the first, something like 9% for a 10% second), payment on $360,000 runs about $2215, plus taxes of $420 per month plus association dues of $350 plus an allowance of $50 per month for insurance. Total $3035 per month. As opposed to $2200 rent. An investor would be down $835 per month even if the place was never vacant and never needed repairs. Prices would need to drop $100,000 at least to cover that. I'm also going to assume you need $10,000 for closing costs out of your own pocket, reducing your down payment to $50,000. Now, I'm going to look 10 years out based upon this situation.

Year 1 2 3 4 5 6 7 8 9 10 11

Value $450,000.00 $374,500.00 $400,715.00 $428,765.05 $458,778.60 $490,893.11 $525,255.62 $562,023.52 $601,365.16 $643,460.72 $688,502.98

Monthly Rent $2,200.00 $2,288.00 $2,379.52 $2,474.70 $2,573.69 $2,676.64 $2,783.70 $2,895.05 $3,010.85 $3,131.29 $3,256.54

Equity 50,000.00 21,008.26 9,995.46 43,151.06 78,608.20 116,526.98 157,078.65 200,446.41 246,826.23 296,427.77 349,475.31

Net Benefit 31,500.00 -108,625.29 -91,384.89 -72,677.63 -52,395.49 -30,423.16 -6,637.55 19,092.60 46,907.31 76,955.83 109,397.24

Now, let's look at suppose prices have come down that same $100,000 in a year, but rents have gone up by inflation - roughly 4%. However, rates are a bit higher - let's say 7 percent. Furthermore, you have $90,000 less $10,000 for closing costs leaves $80,000 down payment. I'm assuming property taxes are based upon purchase price, as they are here in California, but if they don't go down when prices go down, that's going to make a difference of about $100 per month to start and more later on. Let's look 9 years out for an equivalent time frame.

Year 1 2 3 4 5 6 7 8 9 10

Value $350,000.00 $374,500.00 $400,715.00 $428,765.05 $458,778.60 $490,893.11 $525,255.62 $562,023.52 $601,365.16 $643,460.72

Monthly Rent $2,288.00 $2,379.52 $2,474.70 $2,573.69 $2,676.64 $2,783.70 $2,895.05 $3,010.85 $3,131.29 $3,256.54

Equity 80,000.00 107,242.69 136,398.64 167,602.25 200,997.33 236,737.81 274,988.43 315,925.50 359,737.71 406,627.01

Net Benefit 24,500.00 4,200.10 18,090.11 42,543.32 69,346.64 98,702.88 130,831.85 165,971.77 204,380.83 246,338.88

The picture looks much better by waiting a year for the market to get rational - assuming it does. If it doesn't, all you've done is taken that last year of benefits off the first chart, or worse, as perhaps the prices continue to rise for another year. Nor have I assumed that you paid extra on the loan. Quite frankly, once you've killed off that second trust deed, leverage is your friend, and you are better off investing the difference.

The question is "When is Wile E. Coyote going to look down?" Okay, not all that funny, but it has applicability to the situation. As long as everyone is in denial, and there is a market of folks willing to pay those prices, the market is going to stay afloat. What's caused our local sputter is the fact that everyone has "looked down", and they don't like what they see. There is no convincing reason why highly paid jobs have to be even more highly paid so that they can afford local housing here, whereas a large proportion of the jobs in certain cities like Washington DC or New York don't really have the option of leaving, as they are where they have to be. The government isn't leaving Washington DC unless it gets nuked, and the big guns of the financial industry aren't leaving New York unless every other big gun does so. You know better than I to where your city lies on that spectrum. My impression is that where you are is closer to the inelastic employment point. Nonetheless, if the rest of the country "looks down," so will those places that are relatively insulated.

If a 20 percent down payment doesn't pencil out as an investment property, as it doesn't in your case, the question is not "if?" the market is going to adjust, but "when?" and "how?" Here locally, you can almost hear the "pop!" If things are relatively inelastic, employer- and jobs-wise, a long slow deflation may be what occurs. You may even keep current prices while inflation makes things catch up. It's hard to say when I'm not as familiar with your city's economic engine as I am with my own, but here's what happens if prices stay stable for ten years:

Year 1 2 3 4 5 6 7 8 9 10 11

Value $450,000.00 $450,000.00 $450,000.00 $450,000.00 $450,000.00 $450,000.00 $450,000.00 $450,000.00 $450,000.00 $450,000.00 $450,000.00

Monthly Rent $2,288.00 $2,379.52 $2,474.70 $2,573.69 $2,676.64 $2,783.70 $2,895.05 $3,010.85 $3,131.29 $3,256.54 $3,386.80

Equity 50,000.00 53,930.19 58,150.38 62,682.08 67,548.41 72,774.22 78,386.23 84,413.13 90,885.78 97,837.36 105,303.52

Net Benefit -31,500.00 -39,318.42 -47,361.14 -55,634.47 -64,145.15 -72,900.45 -81,908.24 -91,177.08 -100,716.30 -110,536.19 -120,648.06

As you can see, you build up a fair amount of equity, but would have been better off renting and investing the difference.

Which of these scenarios is most likely? Here it's the one attached to the first two tables, except that we're a good portion of the way towards table two right now. Where you are, I'd make an educated guess that you're still looking at table one right now. There's money to be made even there if you buy and hold long enough, but you could be upside down for quite a while.

Thank You for asking, and please let me know if this doesn't answer all of your questions.

Caveat Emptor.

UPDATED here