Open request for ideas and thoughts on DS25 buying a house

[SecondCor521]

DS25 is finishing his undergraduate degree this December and is in the final stages of receiving a job offer to start a full time job three days after finals end. He is currently living with me and we get along fine. He wants to buy a house. He is very very frugal and likes to be smart with his money. I think he'll have decent job stability.

Two paths forward were considered. First, move into an apartment and save up a down payment. Second, stay here at home and save up a down payment. As long as everyone is getting along, we agree that the second path forward is overall the preferable one.

He doesn't know his income details yet, but he did some benchmarking and has a decent idea. After accounting for taxes and expenses, he knows how much he can add to his down payment pile per year.

Roughly and mostly conservatively, he could get to an emergency fund plus a 20% down figure after about two years of living at home. 18 months is, I think, a more plausible number. (If he rented an apartment, it would be more like 5 years, FWIW.)

The real estate market here has really started to take off. My simple logic suggests the idea that if he puts 10% down instead of 20% down and has to pay an additional 1% PMI on the mortgage rate, if house prices are going up by 5%-10% or more (which they are at the moment), that seems like a smart trade. Of course the payment needs to be affordable. And of course the risk of being underwater if prices drop could be an issue, which I would point out to him.

This is really an open request for ideas and thoughts about the financial aspects of a new college grad buying their first home. Questions I have:

1. Is 80/10/10 financing more or less advantageous than PMI? I lean towards 80/10/10, but am curious to hear others' thoughts.

2. I'm aware of the PMI breakpoint at 20% down. Are there breakpoints below that to be aware of? Like is 5% down significantly better than 4.5% down? Is there anything special that happens at 10% down?

3. Which of the first time homebuyer programs / credits / loan options worth looking at, if any? At this point I would recommend 20% down with a conventional fixed rate 30 year mortgage, or an 80/10/10 deal. FHA seems like it might be an option?

4. He'll probably have a 401(k) with a 3% to 5% match. I'd be inclined to encourage him to do that at least to the match, even though it will slow down the house down payment accumulation a little. I know DR wouldn't approve, but I'm an independent thinker. Your thoughts?

5. Overall, entry level houses are a stretch. He can certainly watch realtor.com for new listings, but most of those have already been redone and upgraded with nicer level finishes than he wants or needs. It might be smart for him to try to find a house pre-market. Are there any other tips and tricks for him as an ordinary first time buyer to find a less expensive option - maybe a older decent home with good bones that he can be satisfied with and then maybe fix up over time?

Thanks in advance for the input. I'm sure I've left out some of the picture - I often do - but will generally be happy to clarify / answer questions as long as they don't get into my son's privacy too much.

 

[SecondCor521]

6. Under what circumstances would you recommend holding off buying? The market here, as I've mentioned, has heated up a lot. That could mean we're in a bubble (like Las Vegas circa 2009), in which case it would be smart to wait. Or we could be like Seattle or San Francisco, where prices started going up and have continued to go up for years and years. I am inclined to think the latter, but would be interested to know if there's any way to distinguish.

 

[ivinsfan]

It seems that you have already reached the most important point that he will live at home while he saves money. The way the world and the economy is today I might be content to just leave at that and see what happens going forward.

You've got a smart well motivated son who most likely will be able to figure this out as he matures. It would be good for him to think long and research his options. I don't know all your circumstances but as long as everyone in the house is OK with this arrangement, it seems like a win/win... Congrats on getting him this far and I think he will do fine as he makes choices in the future.


PS Is your DS wanting to strike out on his own, or thinking of this house as an investment.

 

[Freedom56]

I would advise your son to stay with you and save money for a down payment. My parents let me do the same. I graduated at age 21 and started working and started my masters degree part-time. I stayed at home until age 24 and saved enough for a down payment on a new home. Buying that home let me build up equity quickly.

 

[SecondCor521]

PS Is your DS wanting to strike out on his own, or thinking of this house as an investment.

Thanks for the kind words (which I clipped).

He'd buy it to live in himself and is mostly looking at it as a wealth building tool. Around here it seems to me that rents are overpriced compared to houses, and I think he's adopted my thinking on that.

The smallest thing on the market around where he'd be looking is typically a 3/2, rarely a 2/2. He could afford something like that on his own but he's thought of taking in a renter anyway to help out. I suggested he get the job and house ownership squared away first, and then consider a renter, as that's another level altogether and comes with its issues.

He does also want to have his own place for dating reasons, which I can totally understand and support. And to strike out on his own, as you say. These may become a motivation for saving up less / moving out sooner, we'll see.

 

[cathy63]

Does he have a solid credit history and a good credit score? He may not qualify for an 80/10/10 mortgage without one (unless the "Bank of Dad" would be the second lender). It sounds like he'll have a couple of years to build up his credit history, so he should make sure he has a couple of cards and that he uses them and makes timely payments while he's saving.

In addition to avoiding PMI, putting down a larger down payment may also allow him to avoid having an escrow account for the taxes.

His best option might be to sit down with a mortgage broker and discuss what types of loans and programs are available now so he can set some numeric targets he wants to reach. Then he should do that again when he thinks he's getting close, so he's aware of what's changed.

I agree that contributing enough to the 401k to get the match is a good idea. I had one friend who years ago maxed out her 401k and then took a loan from it to put 10% down in addition to the 10% she had saved, essentially treating the 401k as a second mortgage. That worked out great for her because her job was very stable and she had no problem paying off that loan in 5 years, but there are definitely risks to that strategy.

For your last question on when not to buy -- I think a lot of things will become clearer by the time he's saved up a down payment, so it's good that will take him a while. All kinds of markets might do strange things over the next couple of years depending on Covid and people leaving/returning to cities and elections and any number of other influences, so hopefully some of that will shake out before he's ready to put money down.

Also, buying a house ties you down in ways a younger person might not expect. It's a lot harder to quit a job that's making you miserable if you have house payments coming due, so hopefully he'll be in a stable and happy place work-wise by then. Then career opportunities and romantic relationships can also have big impacts on housing decisions. A couple of years from now, his company may want to send him on a temporary assignment somewhere, or he may be in love with someone whose work has to be somewhere else.

 

[OldShooter]

DW and my first house was a duplex in a nice neighborhood. I ecommend it. That launched me on 25 years of small residential landlording. Duplexes, fours, small apartment buildings. Real estate can be great because of leverage. While at the macro level housing costs cannot grow faster than household income, 20% down with the tenants paying the interest gives you a 5x multiplier ride.

Are we talking Boise? I would not buy anything in states or cities with severe financial problems, unfunded public pensions, etc. Chicago, Illinois, California, and others. If you don't already know, which you probably do, you should check on the liability overhang wherever he is considering buying. Stories this week about Illinois' bond issue and tax increases are harbingers.

 

[SecondCor521]

@cathy63, thanks for the comments.

I've added him as an AU on two of my cards - one which is 15 years old with a $34K limit, and one which is 4 years old with a $21K limit. Both have perfect payment records. As far as I know, that is the entirety of his credit history - he sticks all his money into his checking account, taxable account, and Roth IRA and doesn't really buy much of anything. I don't know if that's enough, but I'll have him pull his credit score sometime and see what it is. I'd guess mid-700s, but not sure.

We'll obviously watch the housing market over the next year or two, but even so it certainly could be the case that in two years we'll still have a broken crystal ball and have to guess on housing market direction.

Good point about being tied down. I'll mention that to him.

 

[SecondCor521]

DW and my first house was a duplex in a nice neighborhood. I ecommend it. That launched me on 25 years of small residential landlording. Duplexes, fours, small apartment buildings. Real estate can be great because of leverage. While at the macro level housing costs cannot grow faster than household income, 20% down with the tenants paying the interest gives you a 5x multiplier ride.

Are we talking Boise? I would not buy anything in states or cities with severe financial problems, unfunded public pensions, etc. Chicago, Illinois, California, and others. If you don't already know, which you probably do, you should check on the liability overhang wherever he is considering buying. Stories this week about Illinois' bond issue and tax increases are harbingers.

@OldShooter, yes, I would suggest a duplex to him, and we've talked about it. I'm a tad bit leery of going straight from living at home to being a landlord, but it's an option.

And yes, we're talking about Boise. Idaho' state constitution requires a balanced budget, and our public pension is very well funded. In that vein, though, there can be poorly run HOAs that could do special assessments. I think that happens with condos more, but could be things like common areas, pools, fences, etc.

 

[OldShooter]

... I'm a tad bit leery of going straight from living at home to being a landlord, but it's an option. ...

I didn't find that to be a big deal at all. For one unit the accounting can be done with a spreadsheet and he will know if the rent is paid up to date and, if not, why. He will have to either possess or learn some simple life skills like unplugging a toilet, also some basic business skills like knowing whether he is making any money, cash flow planning, etc. But those are important things to know and with you, his coach, being in town and willing, I think he's in good shape.

In our city there was a "tenants union," not really a union but they published a tenants' rights brochure that covered all the relevant laws and regulations. Something like that would be great reading for a budding real estate baron like your son.

 

[pb4uski]

I like the idea of a duplex, or since from what you wrote prices are appreciating in your area, even a condo with a 80/10/10 loan so he can get his foot in the door... even if the last 10 ends up coming from the bank of Dad. At this point in his life some prudent leverage is a friend. Or perhaps a two bedroom condo and take in a roommate to help with the ownership costs.

At least for me, when I was 25 while I was fiscally responsible I was having too much fun living life and chasing ladies to be ready for a single family home.

 

[Offgrid Organic Farmer]

When my eldest was 25, he bought a four-plex, where he had four tenants. The rental income covered all expenses, and sent him on the path to early retirement.

When I was 26 my wife and I bought our first property, a Tri-plex. It was three houses on one lot. We lived in one and rented out the other two.

We did the same at each duty station. We never owned a single-family-residence until after I retired when I was 42.

 

[ut2sua]

The biggest risk of buying a house is to lose it to the bank in the first 7 years or so (by not being able to make the mortgage payment). If he can have a backup plan in a worst-case scenario (rent it out, go back to living with you during downtime etc.) then it will normally be a great investment.

 

[ivinsfan]

On your number 5, is your son at all handy at fixing? It seems that in hot markets contractors on rehab jobs really jack up their prices. I don't know that it would be prudent to buy something that needs a lot of fixing.

and as cathy63 stated if job or relationships means he needs to move quickly a partially fixed up house probably won't bring top dollar..

 

[SecondCor521]

Replies:

@OS, his undergrad degree is actually a business degree, so he's taken accounting and finance and all that good stuff. I think he could manage the money aspect of things. I think it's more tenant screening and fixing things that would be more a challenge. But he could probably be up to it.

@pb4uski, thanks for the mention of Bank of Dad. That's actually feasible and a good idea. Noted.

@ut2sua, yep, noted.

@ivinsfan, not yet but he seems willing and able to learn. By "good bones" I meant something where the fixing means new carpet and paint and maybe a new toilet, not rewiring knob-and-tube or floor joist leveling type stuff. These type of properties are rare in the area he's looking at, but I have already seen one potential one listed, so they're out there.

Updates:

He was offered and accepted the job this week that I alluded to in my OP. Salary was about 25% higher than his conservative estimate, so that's nice. Plus 401(k), time off, health plan, etc.

He did decide to do the 401(k) up to the match, which I think is an excellent choice.

I discussed the 80/10/10 idea with him - both pros and cons - and he wants to go for it. No real surprise since he has a fairly high appetite for risk. So that makes the move out timeframe approximately a year from now, which is imminently doable.

I've got more ideas to run past him but I'm doing them step-wise so he can absorb them. Next ideas include renting out a bedroom or two, the Bank of Dad idea mentioned above, and a few others.

 

[lhamo]

Congrats on his job offer and the higher than expected salary!


Considering that your withdrawal rates from your own stash are as low as you have reported in the past, have you considered offering to gift him some money -- perhaps as a match to his own savings -- in order to further incentivize him to save/invest? We did something like this for our recently-graduated DS: gifted him 12k as a graduation present with the caveat that he needed to put the same amount into a Roth IRA.

Depending on where he goes for grad school (he's applying for PhD programs in CS), we may gift him additional money so he can buy a place to house hack. Do-able if he ends up someplace like Carnegie Mellon, not so much if he ends up at UCSD....

 

[ivinsfan]

Great report and the two of you have an excellent communication style going, which is at least half the battle for someone his age...

 

[SecondCor521]

@lhamo, there's sort of a three part answer to that:

1. I don't actually need to motivate him, he's already motivated enough on his own.

2. I'll be gifting him the remainder of his college account sometime in the next month or two, which he plans to put into his house down payment fund and will give him a really good start.

3. I do have a super low withdrawal rate, but pretty much all of my assets are tied up in either IRAs or my house. I do have a taxable account that I could use which is about 2/3 basis and 1/3 LTCG, and I'm considering that.

 

[tulak]

6. Under what circumstances would you recommend holding off buying? The market here, as I've mentioned, has heated up a lot. That could mean we're in a bubble (like Las Vegas circa 2009), in which case it would be smart to wait. Or we could be like Seattle or San Francisco, where prices started going up and have continued to go up for years and years. I am inclined to think the latter, but would be interested to know if there's any way to distinguish.

I don’t know of a good way to distinguish. Maybe looking at potential economic growth in Boise?

I’m in Seattle and in retrospect, the growth of all tech companies in this region led to a large influx of workers filling highly compensated jobs. Due to limited housing inventory, this led to an increase in home prices. Especially in areas with high quality public schools. Are there similar trends in your area?

I’m going through a similar exercise with DS, except we’re dealing with a HCOL area. I expect him to graduate next spring with a CS degree. I’m letting him live with me - along with his girlfriend - while saving for a down payment. Otherwise, it would be hard for them to afford a home in this area. I expect that he will be living with me for at least a few years. It’s not a big deal for me, as long as I see they are making progress.

And congrats to your son!

 

[SecondCor521]

@tulak, the trends in Boise are broadly similar to those in Seattle of 10 years ago and make me think that we're probably headed for the same pattern. There is a good vibrant economy, good four seasons weather, and other than housing a relatively LCOL area. Boise has been showing up on those "Best Towns to Live In" lists for the past 5-10 years. My DS25 is looking to buy close to work, which happens to be in the area of town with the best public high school and a very highly rated private high school.

I think the only minor difference is that the Boise area does have some rural land that can be suburbanized whereas Seattle from my knowledge has already done that to pretty much all the available land near downtown. That difference means prices may not rise as rapidly, but they still should climb steadily due to the other factors.

Thanks for making me write that out, as it's fairly convinced me that we're probably not in a bubble situation here, which is helpful input to DS25's plan.

Good luck with your DS too. My undergrad was in CS and from what I know it's still very much in demand these days 30 years later.

 

[38Chevy454]

I bought my first house at 25, after graduating college and working for one year. Thanks to govt contracts, my salary engineer position could get paid OT (at straight time rate, but still was nice to take advantage of). So I just worked 10 hours/day, M-F, and still had weekends off for fun. The extra work made for increased learning and experience for me, along with good impression for mgmt of me. I banked all of that OT money, plus what I could from regular salary. Approx one year of saving and I had enough for the 80/10/10 purchase with my 10% down from my saving. That got me on the home ownership wave and real estate appreciation curve.


I did also take on roommate to help with some of the expense. I would have liked to be by myself, but the extra money was good to help replenish some of the savings.
Congratulations to your son for his new job and having some good financial smarts. He will do fine, especially with your guidance and help.


I was not living at home during that first year, but shared a SFH with a friend roommate who was also new grad like me. Your son living at home should be able to save at a good rate, although I would suggest he should pay rent to you as incentive for him to get out on his own.

 

[OldShooter]

... I think it's more tenant screening and fixing things that would be more a challenge. But he could probably be up to it.

Don't worry about that. If the tenants he chooses are also his housemates in the duplex he will quickly, in just a couple of tenants, learn to screen. He will also have the advantage of being there, so nothing much can go on that he's not aware of. Re fixing, between Home Depot and YouTube he's all set. You get to help, too.

He did decide to do the 401(k) up to the match, which I think is an excellent choice ...

WADR, I disagree. Now is the time to max the contributions.

First of all this gives the money more years to grow. Second, he is about to receive the biggest income he's probably ever had, so he won't miss the bucks going into the 401K. The only reason to not do this, IMO, is if it is a poor 401K plan that loads administrative fees on the participants. Rare, but it happens. In that case, put the dough into a Roth or a tIRA.

 

[ivinsfan]

Don't worry about that. If the tenants he chooses are also his housemates in the duplex he will quickly, in just a couple of tenants, learn to screen. He will also have the advantage of being there, so nothing much can go on that he's not aware of. Re fixing, between Home Depot and YouTube he's all set. You get to help, too.

WADR, I disagree. Now is the time to max the contributions.

First of all this gives the money more years to grow. Second, he is about to receive the biggest income he's probably ever had, so he won't miss the bucks going into the 401K. The only reason to not do this, IMO, is if it is a poor 401K plan that loads administrative fees on the participants. Rare, but it happens. In that case, put the dough into a Roth or a tIRA.

I dunno he's saving to buy a house, not blowing it on sports car. I don't see a problem with it.

 

[SecondCor521]

Don't worry about that. If the tenants he chooses are also his housemates in the duplex he will quickly, in just a couple of tenants, learn to screen. He will also have the advantage of being there, so nothing much can go on that he's not aware of. Re fixing, between Home Depot and YouTube he's all set. You get to help, too.

WADR, I disagree. Now is the time to max the contributions.

First of all this gives the money more years to grow. Second, he is about to receive the biggest income he's probably ever had, so he won't miss the bucks going into the 401K. The only reason to not do this, IMO, is if it is a poor 401K plan that loads administrative fees on the participants. Rare, but it happens. In that case, put the dough into a Roth or a tIRA.

Thanks for the encouragement on the rental front.

I should clarify that the 401(k) up to the match is only until he buys the house and is to minimize the amount of time until buying. So that will last about a year, and that's a 5% deferral with a 5% match. After he buys the house I'm pretty sure he's already planning on maxxing out his 401(k).

The other aspect to it is that home prices here are probably going up 5-10% a year. So if he were to max the 401(k), that would delay the home purchase by several months, which would (in theory) result in a higher home price by a couple of percentage points. Those percentage points would, under current tax code, likely be tax-free on the back end.

The kid has already maxxed out his Roth IRA a couple of times and already has a taxable account as well. If he ends up with extra somehow I'm 99% sure he'll stick it into his Roth or up his 401(k) sooner - he won't be upping his lifestyle.

@38chevy, yes, I'm planning on him paying me a modest rent. Not to motivate him to move out, but just to make his budget more realistic and get him in the habit of making a monthly payment on the first, and to defray his costs of living here (while in school my kids get to live and eat at home for free).

 

[pb4uski]

... WADR, I disagree. Now is the time to max the contributions. ...

IMO, that's crazy. The 401k max contribution is $19,500. The average salary for a new graduate is about $51k, so let's assume that the OP's son is a star and is earning $78k. Do you really expect that a 22 yo is going to save 25% of their gross pay?