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Where to save for that down payment
By Don
Taylor • Bankrate.com
 Dear
Dr. Don,
I want to save for a down payment for a house in two to three years. I am planning
on saving $200 a month. What is the best investment for this given the shaky
economy?
Thanks,
Lesli Leverage
Saving for a down payment
Dear Dr. Don,
I am looking to either save or invest money so that in the next couple of years
I could use it for a house. As of right now, what is the best thing to do as
far as savings/CDs, etc.?
Thanks,
Dale Downpayment
Dear Lesli & Dale,
You shouldn't take on much risk when investing for a short-term goal such as
a house down payment. Contributions to the account mean much more than the actual
interest earned over such a short investment horizon, as shown in the table
below:
| Interest
earned over a short investment horizon |
|
Interest earned:
|
2%
|
5%
|
8%
|
-15.5%
|
|
Monthly savings:
|
$200
|
$200
|
$200
|
$200
|
|
Months saved:
|
36
|
36
|
36
|
36
|
|
Ending balance:
|
$7,414
|
$7,751
|
$8,107
|
$5,787
|
|
Difference:
|
|
$337
|
$693
|
$1,627
|
|
Months to recoup difference when investing at 2%:
|
|
1.68
|
3.47
|
-8.13
|
Nobody invests planning to lose an average 15.5 percent on their
investments, but that's what an investment in the Standard & Poor's 500
did from 2000 through 2002. While it's unlikely that the stock market will continue
its losing streak over the next three years, the point is that it's not worth
taking the chance that it will when investing for a short-term goal.
If you've already started to accumulate a down payment, an aggressive
approach would be to use FHA financing to buy a home today with 3 percent to
5 percent down, capture the current lows in interest rates, and hope that the
real estate market in your community isn't a bubble waiting to burst if mortgage
rates climb higher. The FHA
library can fill you in on this method of mortgage financing, including
lending limits for FHA loans in your community.
The example below shows a situation where housing prices stay
flat, but interest rates rise over the next three years. You dutifully save
your $200 a month at 2 percent and have an additional down payment of $7,414.
Not only is your payment $155 a month higher than you might get in today's market,
but you'll pay an extra $63,000 in interest expense over the life of your loan
-- even with the lower loan amount.
| Stagnant home prices
with rising interest rates |
| |
Buy today
|
Buy in 3 years
|
Difference
|
|
Market value:
|
$159,687
|
$159,687
|
|
|
Loan amount:
|
$154,896
|
$147,482
|
$(7,414)
|
|
Interest rate:
|
6.5%
|
8.5%
|
|
|
Loan term (months):
|
360
|
360
|
|
|
Payment:
|
$979
|
$1,134
|
$155
|
|
Total payments:
|
$352,457
|
$408,243
|
|
|
Total interest expense:
|
$197,561
|
$260,761
|
$63,200
|
I'll be the first to tell you that I don't know where interest
rates will be three months from now, much less three years from now. What I'm
hoping to illustrate with these two examples is that you don't need to chase
return when investing for a short-term financial goal and that rising interest
rates might make you wish that you bought today.
-- Posted: July 1, 2003
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