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Ask Dr. Don

How big a down payment?

Dr. Don,
We are planning to buy a house priced around $280,000. We have savings of $180,000. We are low risk people and don't want to invest in stocks. What is the maximum amount we should put in the down payment. Should we invest in mutual funds and other low risk items? Your suggestion will really help us a lot.
Vandana Veranda

Dear Vandana,
It's a balancing act. It makes sense to put at least 20 percent down, so you don't have to pay private mortgage insurance (PMI). But you don't want to put all your money in the house because you won't be able to readily tap the money if you should need it without taking out a home equity loan.

You should keep some money, from three to six months worth of living expenses, invested in an emergency fund that you can readily access as the need arises.

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If you can use the mortgage interest deduction on your taxes, mortgage money is the least expensive form of borrowing. If you're carrying balances on your credit card or have an outstanding car loan, it would be better to pay off those balances rather than putting more money down on the house. (Unless you have low or zero-percent financing on the car.)

Where would you invest the money if you didn't invest in your home? Would you earn more on these investments on an after-tax basis than the after-tax rate on your mortgage?

If not, then it makes more sense to make a larger down payment. Taking a look at your household budget will also help you decide how much to put down. You want to be able to keep your monthly payments affordable.

Also consider your other financial goals before committing all of your savings to the down payment. Are you participating in tax-deferred or tax-advantaged retirement accounts and college savings plans? It may be better to use some of this money to jump-start these investment plans.

If you don't like the uncertainty surrounding investing in stocks, then stay out of the stock market. It's your money, so you get to choose how it's invested.

Historically, stocks have done a better job than bonds or cash in protecting your portfolio against the ravages of inflation, but investments in real assets, such as your home, also provide inflation protection.

Inflation indexed bonds, such as the Treasury Inflation Indexed notes and bond, and the Series I Savings Bond will provide an inflation-adjusted real return on your investment. The Series I Savings Bond is a little more consumer friendly than the TIIs, and you should consider the income tax implications when investing in either type of security.

-- Posted: Nov. 20, 2001

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