Should You Pay Off Your Starter Home, or Save Cash for the Next One?

Like every other aspect of life, the housing market has gone absolutely wild over the last few years as prices have soared by double digits in basically every market. The median selling price for a house in November, 2021 was 25 per cent more than it was less than two years before, which is, again, wild. And there are exactly zero signs that this is going to change any time soon. Meanwhile, inflation, as you may have noticed, is enormous, which means interest rates are probably going to go up.

All this means a lot of people who had been planning to move to a new home this year are rethinking that plan. Some believe a market correction is due, and don’t want to buy in just as prices peak. Others are nope-ing out simply because they’ve been priced out. Either way, that starter home that was too small or lacking dream amenities is starting to look nice and comfortable all of a sudden.

Some caution is always warranted, but these unprecedented circumstances may have left you in an interesting situation: You’ve scraped together a down payment for a planned move, and are sitting on a good deal of cash. If you’re not going to use it to buy a house right now, what should you do with it: Invest it, or pay down your current mortgage?

Do the math

One thing to keep in mind as you ponder this question: Buying a house isn’t an investment the same way, say, putting that down payment into a mutual fund is an investment. We tend to use the language of “investing” when discussing real estate, but it’s largely metaphorical — houses are awful investments. Yes, they tend to appreciate, but they (usually) do so very slowly. They cost a lot to carry in taxes, maintenance, and insurance — you name it, there’s a bill associated with it. They aren’t exactly liquid; even in a great market, selling a home while figuring out where to move at the same time is a tall order. And upgrading to a more expensive home also means more expenses.

Figuring out whether you should invest that down payment or pay down your mortgage depends on how the maths works for you. Step one is to calculate how much of your current mortgage you can pay off, and how much money that saves you in the long run.

For example, say you have a 30-year fixed mortgage of $200,000 at 4 per cent, and you have 10 years to go on the term. You’re paying an estimated $954.83 a month, and you have about $94,308.78 left in principal. Since the average down payment in the U.S. is around $US28,000 ($38,870), let’s assume that’s what you’ve saved at least that much. If you put that against your current mortgage, you’ll save about $11,000 in interest over the course of the rest of the loan.

Not bad! But if you invest that $28,000 in a generic index fund that delivers a theoretical 8 per cent return (a little lower than the 10-11 per cent the S&P 500 usually manages), by the time you pay off the mortgage your investment would be worth about $60,450 — a bit better than $11,000.

Investing is usually better in the long run

You might have a lot less than $28,000 saved up, but unless your interest rate is a lot higher, typically investing your money is a better deal than paying off a mortgage. That doesn’t mean there aren’t advantages to paying off a mortgage, including saving all that interest, clearing a large debt off your balance sheet, and having 100 per cent equity in your home.

If you’re just delaying your house hunt and want to preserve your down payment for that purpose, how long you intend to wait matters. If it’s a year or less, keeping the down payment somewhat liquid and accessible is a good idea — a money market or savings account may be your best bet. But if you’re thinking it might be a longer wait and you don’t want to pay down your current mortgage with the money, you need to invest it somewhere it will deliver a return, if only to stave off inflation, which will otherwise only slowly reduce the buying power of your down payment. Actually, maybe not even that slowly.

It also goes without saying you shouldn’t rely on this or any article for your financial advice — everyone’s situation is different, so talk to a financial advisor and let them guide you. In the end, there’s no objectively “correct” decision about what to do with that big lump of money you thought you were going to use to buy a new house before the market went all Mad Max on you. The key is to make sure you think through all of your options, do the maths — then make the decision that’s best for you.