Save For A Down Payment or Buy Now? (Part 2 of 2)

(click for Part 1 of Save For A Down Payment or Buy Now?, which deals with the basic question of how well saving for a down payment increases affordability)



But suppose, instead of waiting because you can't afford the payments now, you buy a $250,000 condo now - and then sell it for your down payment later. In other words, you buy what you can afford right now instead of waiting and saving until you can have the home of your dreams. Then at some later time you sell the condo for the down payment on the home you really want.



Let's look at the trade-offs for the condo. I'm going to assume that the condo's equity is the sum total of the saving you are doing, and I'm going to manipulate rents until I get $833 per month cash flow difference (you $10,000 per year savings). This yields a monthly rent of $977.46. You can't rent $250,000 condos around here for $1000 per month, but we'll stick with the situation I figured even though the argument in favor of buying the condo is far stronger. Let's also assume it costs 7% of the value to sell the property, make allowances for property taxes, HOA fees, etcetera. It'd be a bear if I didn't already have the spreadsheet done, but here are the results:

Year 0 1 2 3 4 5 6 7 8 9 10

Value $250,000.00 $262,500.00 $275,625.00 $289,406.25 $303,876.56 $319,070.39 $335,023.91 $351,775.11 $369,363.86 $387,832.05 $407,223.66

Monthly Rent $977.46 $1,016.56 $1,057.22 $1,099.51 $1,143.49 $1,189.23 $1,236.80 $1,286.27 $1,337.72 $1,391.23 $1,446.88

Equity 0.00 15,431.56 31,674.53 48,772.18 66,770.15 85,716.58 105,662.21 126,660.56 148,768.08 172,044.30 196,552.03

Net Benefit -17,500.00 -13,443.41 -9,518.73 -5,769.20 -2,244.10 1,000.56 3,901.27 6,386.11 8,373.86 9,772.91 10,480.08

Now, I have to admit this seems marginal. You've only got an extra $10,000 in your pocket after 10 years. So you sell the condo and buy your house, and plugging these numbers into the affordability spreadsheet improves the affordability of the house you really want by 8% in only 8 years. Nonetheless, this is 2.5 times the affordability increase afforded by investing the money.



Now let's consider the situation as it really exists. That $250,000 condo rents for about $1300, which makes a big difference to what you save. It's like taking the previous situation, and adding $322 per month to your investments as well. Here's the numbers for the condo, adding the investment, and coming up with a total.

Year 0 1 2 3 4 5 6 7 8 9 10

Value $250,000.00 $262,500.00 $275,625.00 $289,406.25 $303,876.56 $319,070.39 $335,023.91 $351,775.11 $369,363.86 $387,832.05 $407,223.66

Rent $1,300.00 $1,352.00 $1,406.08 $1,462.32 $1,520.82 $1,581.65 $1,644.91 $1,710.71 $1,779.14 $1,850.31 $1,924.32

Equity 0.00 15,431.56 31,674.53 48,772.18 66,770.15 85,716.58 105,662.21 126,660.56 148,768.08 172,044.30 196,552.03

Savings $0 $4046.11 $8515.91 $13453.74 $18908.64 $24934.73 $31591.84 $38946.03 $47070.31 $56045.30 $65,960.08

eq+sav $0.00 $19,477.67 $40,190.44 $62,225.92 $85,678.79 $110,651.31 $137,254.05 $165,606.59 $195,838.39 $228,089.60 $262,512.11

Now let's paste these last numbers into the affordability sheet and see what we get:

Year 0 1 2 3 4 5 6 7 8 9 10

available $0.00 $19,477.67 $40,190.44 $62,225.92 $85,678.79 $110,651.31 $137,254.05 $165,606.59 $195,838.39 $228,089.60 $262,512.11

price of house $500,000.00 $525,000.00 $551,250.00 $578,812.50 $607,753.13 $638,140.78 $670,047.82 $703,550.21 $738,727.72 $775,664.11 $814,447.31

payments $3,631.97 $3,670.64 $3,709.34 $3,747.86 $3,786.00 $3,823.49 $3,864.42 $3,928.79 $3,993.62 $4,058.65 $4,123.58

affordability 1.00 1.02 1.04 1.06 1.08 1.10 1.12 1.14 1.15 1.17 1.18

So we see that this strategy has increased the affordability of the house you really want by 12% over only 6 years, holding background assumptions constant. This is twice again the affordability increase rate from the last example (2%/year as opposed to 1), and so almost five times the affordability increase rate of just saving for a down payment. Furthermore, those payments on your condo are mandatory, and the increases in value happen of their own accord, whereas most saving programs run by individuals falter a bit over time, nor is there any such thing as a 10% return per year tax free. In short, I'm comparing a real world real estate investment with a hopelessly idealized other investment. Saving for a down payment makes comparatively little sense unless you are not yet in a position to buy, either due to stability, insufficient income to buy anything, or because your situation does not permit 100% financing.



Taken all together, this forms a powerful argument for not waiting until you can afford your dream house, but buying what you can afford as soon as you are in a position to do so with the intention of trading up later. Delaying means you cut the later years off of the results, not the earlier. The benefits to real estate don't start until you put your foot on the ladder. If I had known this when I was in my twenties, I'd be millions of dollars better off today. So plan ahead, and start working towards your goals now. You can never go back in time with what your figure out later, or with the effort you expend later.



Caveat Emptor