Looking for options to purchase your move-up home? Using your cash reserves to make the down payment on a new home versus funding it through an equity loan (insert link to “Move-Up Buyers, Using Your Home Equity To Move Up) on your primary residence is a matter of the cost of opportunity.
So, if there are investment alternatives out there for your cash which offer a higher real return than the prevailing mortgage rate, it would make numerical sense to invest your cash elsewhere and leverage your home equity to fund the new purchase.
Why Use Cash?
Keep in mind that not investing your cash (basically keeping it in the bank) has a cost as well – the cost of inflation, which reduces the purchasing power of cash over time. Currently that cost, in the U.S., is 2.5% per year. A real return is calculated by subtracting the prevailing annual inflation rate (2.5%) from the nominal return offered by the different investment options available. For instance, if you invested your cash today (3.17) in 30-year Treasury Bonds, the nominal rate of return would be 1.56% per year.
However, your real return, after subtracting inflation, would be negative 0.94%. Therefore, since the current home equity loan interest rate is higher (5.5% as of 3.17), it makes financial sense to use your cash reserves to make as high a down payment as possible on a new home.
Making a higher down payment—20% plus—not only will lower your monthly mortgage payment but save you up to 1% per year on private mortgage insurance, which lenders require for loans with less than 20% down.
Homeowners with little cash reserves but substantial holdings in the stock and/or bond markets—either owned outright or through a 401k plan—often wonder if it’s smart to liquidate their portfolio or borrow against it to fund the purchase of a home.
While such decision is one you should consult directly with your investment and tax advisors, the following are options to leverage your portfolio:
- Investment portfolio as collateral
You can borrow against your stock portfolio by taking out a securities-based line of credit or SBLOC. A typical SBLOC agreement permits you to borrow from 50 to 95% of the value of the assets in your investment account, depending on the value of your overall holdings and the types of assets in the account. SBLOCs generally allow you to borrow as little as $100,000 and up to $5 million. Click here for more information.
- 410(k) loans
Technically, 401(k) loans are not true loans because they do not involve either a lender or an evaluation of your credit history. They are more accurately described as the ability to access a portion of your own retirement plan money—usually up to $50,000 or 50% of the assets, whichever is less—on a tax-free basis. Conventional wisdom advises against withdrawing funds from your 401(k) early; however, borrowing from yourself is different from withdrawing funds permanently and does not incur the same tax penalties as withdrawing funds. If you fail to repay your loan within the allotted timeframe, however, it will be treated as a taxable withdrawal.
Can We Help?
Be sure to consult with both your financial and tax advisors before choosing between a HELOC and a home equity loan. If needed, Julie and our team can provide you with the right references to guide you through the different options available to fund the purchase of a new home.
Then, when you’re ready to move up, you can rely on our experience to help you find and purchase your next home. For more information on how we can best help you with your home-buying goals, please contact Julie at 650.799.8888 or Julie@JulieTsaiLaw.com to schedule a free consultation.