Matt has a question about the best way to save for upgrading his house:

My wife and I bought a small house before our wedding, and we know that eventually (say, within the next five years) we’ll need to move. We’ll want to start a family and will need more space. We purchased our current home with an 80/20 loan, instead of putting down the traditional 20% down-payment. At the time we could afford the payments (and we still can), but just didn’t have the money saved up.

We’re now in a position where we’ve got some financial options — we’ve paid off all our debt (credit, student loans, car loans). Knowing that we have to move, would it be better to pay off the 20% mortgage prior to moving, that way we’ve built up equity and can use that toward the downpayment on our new home? Or should we take the money that we would’ve used to pay off that 20% mortgage and use it to save up for the downpayment directly?

For what it’s worth, our mortgage is about 6% interest. The next house we’re moving into, by the way, will be our last house ever (barring unforeseen shifts in career or any ensuing global chaos).

This is a subtle question. On the face of it, it seems like a better idea to pay down the HELOC (which is the form I’m assuming the 20% mortgage takes). Doing so nets a 6% return on investment. Saving the money instead would probably only yield around 4% (if placed in a high-yield account or certificates of deposit).

On the other hand, the interest difference is small enough, and the time frame is so short, that Matt may want to consider the flexibility he’d gain by having the money in liquid investments (such as a savings account).

When we bought this house three years ago, my bank allowed me to take out a home equity loan to get money for a down payment despite the fact I intended to repay the loan in only two months. The bank’s lending rules prohibited this maneuver, but my loan officer processed the loan anyhow, and told me not to mention my intentions to anyone else. I would have rather had the money in a savings account, ready to be put to use.

As I say: this seems like a subtle problem. I’m not sure there’s a best answer. That’s where you readers come in. Do any of you have experience with a situation like this?

(Ryan asked a related question in January: How do you buy one home while selling another?)

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