When Do You Stop Putting Money Down on a House and Start Putting it in a Bank Account?

BY Business Desk  January 26, 2009 at 10:09 AM EDT

Homes for Sale; AP photo

Question/Comment: Dave and I want to know: Pretend you want a house that costs $500,000. You have $500,000 saved up. In this market, when you can get a five percent interest rate (at least) on your 30-year mortgage, is it better to put all of the money down and owe nothing, or to pay a 20 percent down payment, pay a mortgage, and earn (paltry) interest on the remaining savings?

The corollary is, supposing you are not staying in the house for 30 years (and instead plan to be there for five years, let’s say), is it NOT in your best interest to invest in the stock market given that you are not balancing out long-term mortgage payments with long-term gains?

In other words, what is the “tipping point” in these two situations—where do you stop putting money down on a house and start putting it in a bank account or the stock market because you’ll make better-than-five percent returns on your money?

Paul Solman: Interesting question from an emailer close to home. Leaving aside the issue of how long you’re intending to stay in your house, let’s look at the numbers.

You pay five percent on a 30-year fixed-rate mortgage. If you can get a guaranteed five percent on an investment over the same period, it’s a wash: makes no difference. But right now, U.S. Treasuries with a 30-year maturity are paying three percent. (You can look this up on Bloomberg to get the current number.)

In theory, any investment paying more, even a Triple-A rated municipal bond fund, entails taking on more risk. But on the same Bloomberg page to which I’ve linked above, if you scroll down, you’ll see that 30-year municipals are paying five percent and they’re TAX FREE. Bloomberg shows you their equivalent yield to taxable investments if you’re in the 28 percent marginal tax bracket: almost SEVEN percent.

For simplicity’s sake, let’s assume your marginal income tax is 30 percent. Since mortgage interest is deductible, the after-tax rate of interest is roughly 3.5 percent. (That is, you pay five percent but get back 1.5 percent in lower taxes.) The lower your tax rate, the closer your real rate is to five percent.

But if you’re at any substantial marginal rate, then you’re paying close to 3.5 percent after taxes. If you then invest in tax-free municipals at five percent . . . And since you’re in Massachusetts, you can invest in a Massachusetts-only municipal bond fund and avoid Massachusetts taxes too.

There is a risk, of course. Suppose a number of the bond issuers default, as Orange County, California did in 1994; the Washington Public Power Supply System (WPSS or “woops”) in 1983; New York City in 1974? If in your portfolio of bonds, issuers go under, that would lower the yield.

As to the length of time you’re in your house, for the first 15 years or so, most of your mortgage payments go for interest.