Buying Your First Home

A home is not an investment in the portfolio sense. It is a place to live, a hedge against rent increases, and an appreciating asset. But it is also the largest deployment of capital most people make. The mistake is funding it by liquidating long-term investments. The right approach is to save separately for the down payment, and leave your portfolio alone.

Key takeaways

• A down payment should be saved separately from your retirement and long-term investment accounts; 3-5 years is a reasonable timeline to accumulate 20% down (the amount that avoids PMI).
• Pulling capital from retirement accounts (401(k), IRA) for a home purchase is a mistake in almost all cases; the penalties and lost growth far exceed any benefit.
• A mortgage is cheap debt compared to other debts; in a low-rate environment, borrowing at 6% to 7% is reasonable if it means not liquidating your portfolio.
• The allocation for a down-payment bucket depends on the timeline: 1-2 years, conservative (bonds/cash); 3-5 years, moderate (40/60 stocks/bonds); 5+ years, growth (70/30).
• After you buy the home, do not stop investing. Your portfolio still needs to grow toward retirement, even though you now own real estate.

The down-payment bucket

A home purchase should be planned 3 to 5 years in advance. This is not because the market says so, but because it takes time to save for a down payment without raiding long-term investments.

Here is the math: suppose you want to buy a $400,000 home with 20% down ($80,000). Your household income is $120,000, and you can save $1,000 per month after all other expenses and retirement contributions. How long until you have $80,000?

$80,000 / $1,000 per month = 80 months = 6.7 years.

If you have a five-year timeline, you can save $5,000 per month (by skipping something else) or accept a lower down payment (15% down, using PMI—private mortgage insurance—for the rest).

The key is treating the down payment as a separate goal with a separate bucket. Do not mix it with your investment portfolio. If the S&P 500 crashes two months before you buy a home, you do not want to have to delay because your "down payment" lost 30%.

Establish a savings timeline:

• If you plan to buy in 1-2 years, use a high-yield savings account (currently 4-5% APY as of 2024). No investment risk.
• If you plan to buy in 3-5 years, use a moderate allocation (40/60 stocks/bonds) or a target-date fund. Some risk, but time to recover from a dip.
• If you plan to buy in 5+ years, use a more growth-oriented allocation (70/30) until you hit the 5-year mark, then shift to conservative.

The accounts to use: a regular savings account (for 1-2 year timeline), a brokerage account (for 3-5 year timeline), or a money market fund bridging the gap.

How much down payment is required

Conventional wisdom says 20% down. This avoids PMI (private mortgage insurance), which is an additional insurance premium charged by the lender if you put down less than 20%. PMI costs 0.5% to 1% of the loan amount annually, which is real money.

Example: A $400,000 home with 10% down ($40,000) means a $360,000 mortgage. If PMI is 0.75%, that is $2,700 per year in additional cost. Over a 30-year mortgage, that is $81,000 in extra cost.

However, 20% is not always necessary:

• FHA loans: Allow 3.5% down for first-time homebuyers. PMI is higher (0.85% annually), but you do not need 20%.
• VA loans: 0% down if you are a military veteran.
• Conventional loans with PMI: 5-10% down is common; you pay PMI until you reach 20% equity.
• Strong income, low debt: Some lenders allow 10% down with lower PMI if your income and credit score are strong.

The math: if you can save 10% down ($40,000 on a $400,000 home) and you have a 30-year mortgage at 6.5%, and PMI is $2,500 per year, the extra cost is $2,500 annually until your principal balance drops to $320,000 (80% of the home value), which might take 6-8 years. At that point, you can request PMI removal.

Is it better to wait 3 more years, save another $40,000, and avoid PMI? Or buy now with 10% down and PMI? The answer depends on:

• How fast home prices are rising in your market (if prices rise 4% per year, waiting costs you).
• Your rental situation (are you in an expensive rental, or a cheap one?).
• Your life timeline (do you need to buy now for family reasons?).

There is no universal answer. But do not feel forced to wait for 20% down if you can afford the mortgage and the PMI. Some PMI is better than indefinite renting, especially if rent is high.

The mortgage decision

A mortgage is cheap debt. At 6.5%, you are borrowing at less than your expected stock market return (historically 10% nominal, 7% real). This does not mean you should borrow as much as possible; it means a mortgage is not a financial emergency.

Borrowing $300,000 at 6.5% for 30 years costs about $2,000 per month in principal and interest. If you have a household income of $120,000 (after-tax income of about $90,000, or $7,500 per month), the mortgage consumes $2,000 / $7,500 = 27% of gross income. Lenders typically allow up to 28% of gross income for mortgage payment, and up to 43% for all debt. So a $300,000 mortgage is reasonable on a $120,000 income.

The decision is not "mortgage or cash." It is "mortgage or do not buy." Holding off on a home purchase for years in hopes of accumulating a $400,000 down payment means you are paying rent, missing the hedge against rent increases, and not building equity. A mortgage allows you to get into the market sooner, even if it means PMI for a few years.

The retirement account trap

A critical mistake: pulling $50,000 from your IRA or 401(k) to fund a home purchase.

If you are under 59½ and you withdraw from a traditional IRA or 401(k), you owe income tax on the withdrawal plus a 10% early withdrawal penalty. On a $50,000 withdrawal, that might be $15,000 to $20,000 in taxes and penalties, leaving you with only $30,000 to $35,000 to put toward the down payment. You have turned a $50,000 asset into $30,000 cash.

The exception: some 401(k) plans allow loans (not withdrawals), which you can repay over time without taxes. And the IRS allows a one-time exception for first-time homebuyers to withdraw up to $10,000 from a Roth IRA (contributions, not earnings) without penalty. But these are narrow.

The much better approach: if you cannot afford both a home down payment and retirement savings, buy the home with a conventional mortgage and PMI, and keep contributing to retirement accounts. The compound growth you preserve by keeping retirement accounts untouched far exceeds the PMI you pay.

Mortgage rate environment

Mortgage rates change constantly. As of 2024, rates are around 6-7%. In 2020-2021, they were around 2.5-3.5%. In 2010-2012, they were around 3-4%. The rate you get depends on when you buy and your credit score.

If rates are low (under 4%), locking in that rate is valuable. If rates are high (over 7%), the cost of borrowing is steep, but it still might be better than renting, depending on your local market.

A rule of thumb: if the monthly mortgage payment (principal, interest, taxes, insurance, HOA) is more than 1.5 times your monthly rent for a comparable home, you are better off renting. But this varies by market. In expensive markets, renting is often the financially superior choice; in cheap markets, buying is almost always better.

The mortgage and your portfolio

A common mistake: buying a home with a 20% down payment and feeling like the other 80% should be in bonds (because you "have real estate risk").

This is wrong. Your home is not an asset in your investment portfolio. It is a place to live. Your investment portfolio should still follow your target allocation (60/40, 70/30, whatever your IPS says) based on your time horizon and risk tolerance.

Why? Because your home is illiquid. You cannot sell your bedroom to raise cash. If a job loss happens or a market downturn hits, you cannot liquidate 10% of your home. Your investment portfolio needs to be diversified and appropriately allocated independent of your home.

Some people feel wealthy once they own a home ("I own $300,000 in equity!") and reduce their investment portfolio to bonds, trying to be conservative. This is a mistake. Your home is part of your total wealth, but it should not change your investment allocation. If anything, the fact that you own real estate (an inflation hedge and a productive asset) might justify higher stock exposure in your investment portfolio, not lower.

After the purchase

Once you buy the home, your financial life changes in several ways:

1. You have a large debt (the mortgage). This is fine, but your emergency fund should now be larger, maybe 6-12 months instead of 3-6. Job loss becomes more serious when you owe $300,000.

2. Your portfolio must still grow to retirement targets. Do not stop contributing. If you were saving $1,500 per month for a down payment, and now you don't need to, redirect that $1,500 to your 401(k) or IRA or brokerage account.

3. Your housing expenses are now fixed (mostly). This is great for budgeting. When rent rises, you do not care; your mortgage is locked in.

4. You have new expenses: property tax, home insurance, maintenance (budgeting 1% of home value per year is reasonable). These are not surprising costs, but they are real.

5. Your home is now your largest asset. Make sure you have enough life insurance to pay off the mortgage if you die (or enough that your spouse can cover the mortgage from other assets or income). Update your will to specify what happens to the home.

The home-buying decision flowchart

Next

A home is the largest physical asset most people buy. But what if that home is in another country? International relocation brings new portfolio complications: tax residency changes, account portability issues, and currency risk. The next article addresses the financial mechanics of moving abroad.

Related concepts

• Relocating Internationally