Once upon a time there were three little pigs. (I'm surprised I haven't done this in the past year.) The pigs have a grand adventure in store for them involving building supplies and poached wolf, but for today we're starting at the beginning of their story, and that means it's math time.
They were each sent out into the world to make their fortunes. When it came time to buy housing, their mother gave each of them a surprise gift of $5000 in addition to the money they'd already saved.
Now, let's say that they'd each saved up the same amount of cash, had similar credit scores, and all bought $300k townhouses in the same development using FHA loans with 3.5% down. (I know that isn't how the story goes, but I'm not talking about construction materials today.) However, each one chooses to do something different with their $5000 gift from their mother.
Pig #1: $5000 on new appliances.
The youngest pig spent the extra $5000 on new appliances for his kitchen. He got a new Fridge ($1300), a new stove ($1300), and a new washer and dryer ($1200 each). Ten years later when he sells the property he'll have spent $154837 in debt service on his mortgage. His appliances would be close to the end of their useful lifespans, so they won't contribute much to the value of his home. In fact, he might have to replace them all again in order to sell the property.
Pig #2: $5000 towards the down payment.
The middle pig was quite content with the appliances that the developer provided, so he chose to add $5000 to his down payment. This lowered the amount that he had to borrow from the bank. When he sells his property ten years later, he'll have paid $152163 in debt service. This means he'll have saved $2674 over his younger brother. He'll still have to replace the appliances before he moves out, but he'll at least have saved a nice bit towards the cost.
I should note here that given the same 3.44% interest rates on their loans (which happens to be the current national average), it doesn't matter what the down payment was nor what the cost of the property was. Over 10 years, the savings will always be $2674 if you add $5000 to the down payment.
Pig #3: $5000 towards 1.5 Discount points.
We've talked about mortgage discount points before. Basically, for a fee equal to 1% (one "point") of your loan paid up front, your interest rate lowers by a specific amount, usually 0.25%.
The eldest pig used the $5000 to purchase 1.5 discount points on his mortgage, lowering his rate by 0.375%. His brothers got loans at 3.44%, but he came in at a cushy 3.065%. Over the next ten years he will spend $147686 on his loan, saving $7151 compared to his youngest brother. This means he'll actually make a profit on his mother's gift! (Thanks, Mom.) He'll also have accrued $3055 more in equity on his townhome than his younger brother, meaning he can replace the appliances and still walk away with a nice $5000 in savings.
Needless to say, the eldest pig made the smart move here.
The moral of the story is that cash at closing can be spent in many different ways, and that bulking up your down payment is not always the best way to go. First time buyers rarely think about mortgage discount points. In fact, residential buyers often don't consider points at all, unless they are required to pay them in order to get a loan in the first place. However, if you have the cash to spare and today's already ridiculously low rates aren't good enough for you, spending some extra dough to push the rate down even further can have a very good effect on your bottom line. Of course, your mileage may vary and you should always run the numbers yourself after a hearty conversation with your lender.
We also learn that an extra $5000 can go a very long way. When saving cash to purchase a home, every bit helps.
See you Monday.