Home Buying Kit For Dummies. Eric Tyson

As with all informed investing decisions, which investment(s) you consider for money earmarked for your down payment should be determined by how soon you need the money back. The longer the time frame during which you can invest, the more growth-oriented and riskier (that is, more volatile) an investment you may consider. Conversely, when you have a short time frame — five years or less — during which you can invest, choosing volatile investments is dangerous.

      When the stock market is rising, some folks are tempted to keep down-payment money in stocks. After all, when you’re getting returns of 10, 15, 20 percent or more annually, you’ll reach your down-payment savings goal far more quickly. Greedier investors lusting after high-flying technology and Internet stocks that seem to double in value every 90 days hope to quickly parlay their small savings for a shack into a money mountain for a mansion.

      BUYING A HOME WITH “NO MONEY DOWN”

      More than a few books written by (and high-priced seminars led by) real estate “gurus” claim that not only can you buy property with no money down but also that you can make piles of money doing so. A generation ago, this way of thinking was popularized by Robert Allen in his book Nothing Down.

      Allen says that the key to buying property with no money down is to find a seller who’s a don’t-wanter — that is, someone who “will do anything to get rid of his property.” Why would someone be that desperate? Well, perhaps the person is in financial trouble because of a job loss, an overextension of credit, or a major illness.

      Perhaps when more people used to live in smaller, tight-knit communities where everyone supported one another, this type of vulture capitalism may not have flourished. But in these times, Allen says, a don’t-wanter can offer you the most favorable mortgage terms, such as a low down payment and interest rate.

      How do you find such downtrodden souls who are just waiting for you to take advantage of them? According to Allen’s estimates, 10 percent of the sellers in the real estate market are don’t-wanters. Simply call people who have property listed for sale in the newspaper, or place ads yourself saying that you’ll buy in a hurry.

      In our experience, finding homes that can be bought with no money down isn’t easy to do. If you can find such a desperate seller, be aware that the property may have major flaws. If the property were a good one, logic dictates that the seller wouldn’t have to sell under such lousy terms. Should you have the patience to hunt around and sift through perhaps hundreds of properties to find a good one available with seller financing at no money down, be our guest. Just don’t expect the task to be easy or all that lucrative. Better to look for good properties and low-down-payment lender financing and to start saving a healthy down payment so you can qualify for a better loan.

Investing down-payment money in stocks is a dangerous strategy. Your expected home purchase may be delayed for years due to a sinking investment portfolio. Stocks are a generally inappropriate investment for down-payment money you expect to tap within the next five years. More aggressive individual stocks should have an even longer time horizon — ideally, seven to ten or more years. Consider what happened to the home-buying dreams of folks who foolishly parked their home-down-payment money in the stock market before and during the severe stock market decline of the early 2000s and the steep decline of 2007–08.

      Investments for five years or less

      Most prospective home buyers aren’t in a position to take many risks with their down-payment money. The sooner you expect to buy, the less risk you should take. Unless you don’t expect to buy for at least five years, you shouldn’t even consider investing in more growth-oriented investments, such as stocks.

      Although it may appear boring, the first (and likely best) place for accumulating your down-payment money is in a money market mutual fund. As with bank savings accounts, money market mutual funds don’t put your principal at risk — the value of your original investment (principal) doesn’t fluctuate. Rather, you simply earn interest on the money that you’ve invested. Money market funds invest in supersafe investments, such as Treasury bills, bank certificates of deposit, and commercial paper (short-term IOUs issued by the most creditworthy corporations).

      

If you really want to save through a bank, shop, shop, shop around. Smaller savings and loans and credit unions tend to offer more competitive yields than do the larger banks that spend gobs on advertising and have branches all around. Remember, more overhead means lower yields for your money.

      In addition to higher yields, the best money market funds offer check writing (so you can easily access your money) and come in tax-free versions. If you’re in a higher income tax bracket, a tax-free money market fund may allow you to earn a higher effective yield than a money fund that pays taxable interest. (Note: You pay tax only on money invested outside tax-sheltered retirement accounts.) When you’re in a high tax bracket (refer to Table 3-2 earlier in this chapter), you should come out ahead by investing in tax-free money market funds. If you reside in a state with high income taxes, consider a state money market fund, which pays interest that’s free of both federal and state tax.

The better money market funds also offer telephone exchange and redemption and automated, electronic exchange services with your bank account. Automatic investment comes in handy for accumulating your down payment for a home purchase. Once per month, for example, you can have money zapped from your bank account into your money market fund.

      

Because a particular type of money market fund (general, Treasury, or tax-free municipal) is basically investing in the same securities as its competitors, opt for a fund that keeps lean-and-mean expenses. A money fund’s operating expenses, which are deducted before payment of dividends, are the major factor in determining its yield. As with the high overhead of bank branches, the higher a money fund’s operating expenses, the lower its yield. We recommend good ones in this section.

      When you’re not in a high federal-tax bracket, and you’re not in a high state-tax bracket (that is, you pay less than 5 percent in state taxes), consider the following taxable money market funds for your home-down-payment money:

       Fidelity Government Cash Reserves ($0 to open)

       Vanguard Prime Money Market ($3,000 to open)

      You can invest in a money market fund that invests in U.S. Treasury money market funds, which have the backing of the U.S. federal government — for what that’s worth! From a tax standpoint, because U.S. Treasuries are state-tax-free but federally taxable, U.S. Treasury money market funds are appropriate when you’re not in a high federal-tax bracket but you are in a high state-tax bracket (5 percent or higher). Should you choose to invest in a money market fund that invests in the U.S. Treasury, consider these:

       Fidelity Government Money Market ($0 to open)

       USAA Treasury Money Market ($3,000 to open)

       Vanguard Federal Money Market ($3,000 to open)

      Municipal (also known as muni) money market funds invest in short-term debt (meaning that it matures within the next few years) issued by state and local governments. A municipal money market fund, which pays you federally tax-free dividends, invests in munis issued by state and local governments throughout the country. A state-specific municipal fund invests in state and local government-issued munis for one state, such as New York. So if you live in New York and buy a New York municipal fund, the dividends on that fund are generally free of both federal and New York state taxes.

So