Drawbacks of making a large down payment?

27 Replies

We are hoping to buy our first buy-and-hold property by the end of this summer. We feel like we've been analyzing properties ad infinitum and just need to take action! We live in the East Bay Area (Livermore) and would like to buy locally but what we could afford here would mainly be condos/townhomes; not sure we like not having full control over the property. We both like the Folsom/Roseville area (near Sacramento where we are from) and find ourselves in those areas several times a month visiting family. We've read the advice on not to buy any property with negative cash flow. It seems, though, that if we put a larger down payment, we can create positive cash flow. We know that reduces some leverage, but we are somewhat conservative and don't necessarily want to leverage to the hilt. The question is (and maybe there is no right answer): is it advisable to put more than 20-25% down for the sole purpose of generating positive cash flow? What are the negatives of that if we plan to only hold one or two properties for the long term? We already have a significant (to us) chunk of money in stocks and would be investing in real estate solely to diversify our holdings. Would that change the answer? Looking forward to hearing your thoughts and advice. Thanks!

with 0% interest using a down payment to generate cash is a good idea The only problem is if you ever need the cash you would have to refinance it out of the property If you can put down 20% on a property and generate 8-10-15% returns you are doing much better then leaving it in a bank and collecting nothing

I apologize for the formatting; it didn't come through how I typed it on my phone.

I live in Roseville  and have followed our prices for a little over 20 years. You can buy a house in the older part of Roseville for 200k and put 20% and break even if you hire a property manager. I am assuming 1200 in rents which might be low but I wanted to be conservative and your piti comes out to $1100.0 per month.So you have invested 40k that is not earning any income other than the hopes for appreciation and having the loan balance go down. If you put 10k more down that only drops your payment by $52.0 per month. What is more important to you?  $52.0 per month or the 10k in your account? I have invested and been in the mortgage business for years so if you have any more questions about the subject, don't hesitate to ask.

It doesn't sound like your property is making enough money. To me it sounds very dangerous. If it was me, I would take money out of stocks and bonds to use for a 20% down payment on a more expensive property that cash flowed better. In most markets there is a "sweet spot" ($ amount) where the houses cash flow the best. If you can't cash flow paying retail (house on MLS), you may want to consider rehab and holding.

Ps: If what Gordan says is true, your going to go negative in your cash flow. Which at that point, your better off investing elsewhere. If it only rents for $100 over Principle and Interest, you still haven't figured maintenance costs, vacancy, HOA's etc etc.

Please look elsewhere or network with current investors in the area to learn how they're making their 12%-15% returns.

Investing in real estate means making money. So, that means you dont go negative. With that said, figure a amount that your cash is worth now. You say they are in stocks- whats the return? Figure that as your cost of funds. Factor that in the deal. You may want to put more money as a down or less depending how it works out. If you cant NET $200 per property - WALK. good luck

@Samir S.

What are some of the parameters that you're looking for ie purchase price, your equity available for a downpayment, potential rent, estimated expenses etc.? No one can really answer the question without these details, every deal is different. 

I'd advise against a condo/townhome, you'd be better off buying a house in Folsom/Roseville if you can afford it. The HOA fees are definitely going to kill your cash flow potential each month and you will need to analyze the HOA's viability and their reserve account and projected capex allocations for the future. Take the plunge and buy a SFR if you can.

@Gordon Cuffe

I like your explanation; that made us see things in a different light.

We feel like over the long run, prices/rents in Roseville/Rocklin/Folsom will hold steady and/or appreciate, so breaking even and keeping the extra $10K on the sidelines for repairs rather than putting it toward the house just to gain $52/month in cash flow is what we'd lean toward.  All the while, someone else will be paying off the remaining loan while the place is rented.

Thank you for taking the time to reply.

@John Santero

I agree about analyzing the trade-off between stocks vs. property.  Although we have been doing well in the stock market, it may just be simple luck because of the bull run we've had the last several years.  We are not heavy traders; we (generally) buy and hold shares and plan to support ourselves partially from the dividend income they provide.

Why do you use $200 net per month as the "walk" limit?  Just a personal preference?

@Alex Vidal

Thanks for your input. We are looking at properties up to 450K. That gets a condo in the East Bay area or a SFH in Roseville/Rocklin/Folsom.

The HOAs here in the Bay Area seem excessive which really turns us off on some properties. We also hate the special assessments that the HOA can charge for repairs. It just feels like we are giving up too much control by investing in a condo/townhouse.

@Samir S.

 Welcome to BP. I'm from San Jose and I invest in Sacramento. Also, please add line spacing to your original post, it makes it easier on the eyes. Remember 5 sentences = one paragraph (god i hated English class).

Two things: When analyzing a property, don't mix the value/earning power of the property with your own personal financing. Because if you go to sell this property other investors will consider the former not the latter. 

Analyze the property based upon it's current asking price, and how much income you can bring in (after expenses, not including mortgage). If it turns out the property is barely earning a return, then it's time to look for another property.

Currently the market in Sacramento is starting to heat up again, so price to income values on properties I'm seeing is high which means the return on investment is low. Now doesn't mean you can't find a great deal, but it means you will have to look harder for it.

Think, if you took the same money and threw it into a 401k, you would earn a tax and effort free return in stock somewhere around 6%~ a year (Based on historical returns from 1800s to today). Now if you took that money and invested it in a over priced piece of property, you would now earn a lower return and you would have to spend a lot of time maintaining it.

Regarding a larger down payment, I'm all for that because it means your mortgage payment is lower and you have a higher margin of safety, HOWEVER, if the underlying asset is not returning much, I wouldn't advise increase in the down payment to make it look as if the investment is doing better than it really is.

I say to thee KEEP LOOKING and BE PATIENT. You'll eventually find a good deal.

Updated almost 3 years ago

Correction, I should have added contributions to 401k are tax free and returns are taxed. While a roth is post tax, but returns are free after 59 1/2

@Samir S.

I like the explanation of your first post. This is one of the great things about investing in real estate: everyone can do it differently. As long as you understand what you are giving up, and recognize that you are willing to do that because you are conservative and interested in higher cash flow, then you already know what you should do. Just because it's not the best ROI you could achieve doesn't mean it's not the best investment for you

If you can and want to take that extra $10k put it into another property, then you should consider that, but it doesn't sound like you are interested in doing that. I like that you fully understand your situation and are prepared to take action in a way that makes sense and is comfortable for you. Don't be talked into doing something you don't want to do because other people say it's the best way to invest. It's okay for your goals to be different from others'.

Originally posted by @Jordan Thibodeau :

@Samir S.

Remember 5 sentences = one paragraph 

Off topic: but as an English teacher, I can't let this stand!! No wonder you hated English class; it sounds like your teacher was an idiot. There is no low or high end limit to the number of sentences in a paragraph. That's just something impatient teachers say to get kids to stop asking. You can write as many sentences as you need to in order to explain the topic of your paragraph, which is a much more difficult concept to teach.

And now a lesson in irony: the previous paragraph contains five sentences.

Originally posted by @Samir S. :
I apologize for the formatting; it didn't come through how I typed it on my phone.

 This happens to me a lot when I use the phone app.  I type perfectly reasonable paragraphs and spacing, hit send, and then it shows up all mashed together as a post making me look like I've got a strange stream of consciousness going.   

Originally posted by @Jordan Thibodeau :

@Samir S.

Think, if you took the same money and threw it into a 401k, you would earn a tax and effort free return in stock somewhere around 6%~ a year (Based on historical returns from 1800s to today). 

Jordan - Big red flag, a 401K's gain is not tax free...A Roth 401K's and a Roth IRA's are.

Samir - Go the SFR route and make a downpayment at the point where you can achieve the lowest possible 30 year fixed interest rate and still be able to cash flow $200-$300/Mo. That way you can have a slight cushion and build up a war chest to prepare for capex. It'll also allow you to lock into the current extremely low interest rates before they rise.

@Alex Vidal

Correct, I should have added contributions to 401k are tax free and returns are taxed. While a roth is post tax, but returns are free after 59 1/2

@Kevin Siedlecki It's a rule of thumb. If you're honestly saying that his first post was stylistically correct, I would have to disagree. Too many people post on these forums with one gigantic paragraph that's almost impossible to read.

@Samir S.

 I didn't know about the android bug, apologies.

@Jordan Thibodeau - oh I agree: the original post was not formatted properly. Just having some fun with language was all. 

Typically, to get an investor non-owner occupied property, you need 20-30% down.  Often you need a sizable amount in the bank as well.

When I was purchasing, I needed 12%+ returns even with the $80-$100K down, to consider the property.

@everyone - sorry, I was out of town on business and didn't have a chance to reply.  I appreciate all of the input I have received.  It's really making me think about my options.

@Jordan Thibodeau

Hmm, I *could* just toss the money into the 401K (but I hate doing that because I cannot pick individual stocks, only mutual funds...blech!).  Also, I think I can do better by leveraging my money in real estate.  This is sort of my "speculation" money so I am OK with not earning as much up front with the chance that the house will appreciate.

@Kevin Siedlecki - "Just because it's not the best ROI you could achieve doesn't mean it's not the best investment for you."

This hits the nail exactly on the head.  I am semi risk-averse by nature and so putting such a huge amount down in one place seemed risky to me.  But I think that if I buy in a good location and stick with it through the ups and downs, I'll come out ahead in the long run.  It's a calculated risk, but one that I am willing to take.  Thanks for the motivation!

@Alex Vidal

The more I think about it, the better a SFR looks to me. I also don't mind putting more than 20%-25% down in order to cash flow; I like long-term investing and think that I will come out ahead in the long run by going this route

Thanks for taking the time to reply!

@Jordan Thibodeau

 No android for me; that was from iOS! :)

Hopefully the bug will be fixed...

Originally posted by @Samir S. :

@everyone - sorry, I was out of town on business and didn't have a chance to reply.  I appreciate all of the input I have received.  It's really making me think about my options.

@Jordan Thibodeau

Hmm, I *could* just toss the money into the 401K (but I hate doing that because I cannot pick individual stocks, only mutual funds...blech!).  Also, I think I can do better by leveraging my money in real estate.  This is sort of my "speculation" money so I am OK with not earning as much up front with the chance that the house will appreciate.

Why not a Roth IRA?

Also, betting on appreciation is good way to lose money on RE. I would much rather have you put money in the stock market if you're trying to make an appreciation play. 

If you can't find a solid RE investment, then consider an REIT if you are focused on RE diversification.

Have you thought about note investing? 

@Samir S. it sounds like you need to figure out what you really want from your investments. There are a ton of options out there in not only in real estate but wealth building in general. The best question I was asked when I started to determine my avenue of investing was "what is my ultimate goal? What do I want my investments to achieve for me?" Once you really determine that answer, I think it will be easier to chose the avenue you will use your available funds in. 

If it's cash flow to supplement your current income, then go from there. If it's long term equity (cash flow is of no importance) then use that as the determining factor. From there you can determine what yield you require on each deal, or as @John Santero said, a specific net cash flow because everyone's cash flow requirements per door is different. 

I wish you luck! 

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