If you're tired of paying rent but don't have enough cash or home equity for a down payment on a home, selling stocks may be the best option available to you. While we at the Fool encourage investing for the long run, sometimes selling some of your stock portfolio can produce the best outcome for your overall financial health.
If you're thinking about buying a home and are considering the sale of some stocks (or other investments) to finance the down payment, here are a few things to keep in mind.
Once you decide on a house, sell right away
If you sign a contract on a home and obtain mortgage approval, go ahead and get your down payment set aside. Otherwise, you could be leaving the successful closing of your loan to the mercy of the stock market.
Let's say you just obtained mortgage approval and need to sell $20,000 worth of stock to come up with your required down payment and closing costs. After considering your options, you decide that the best way to do it is to sell your 40 shares of Google (NASDAQ:GOOG) (NASDAQ:GOOGL), which are currently trading for about $500 each.
If between now and your closing date Google has a bad quarterly report or other negative catalyst that drives the share price down to $450, then your shares are suddenly worth only $18,000, and you need to sell another $2,000 worth of stock just to close on your house.
Of course, it's entirely possible that Google's share price will jump before your closing date. However, your home purchase is nothing to gamble with.
Look for the best tax outcome
When deciding which stocks to sell, you should consider which ones will produce the most favorable tax outcome. The IRS taxes capital gains in two ways, depending on how long you've owned the stock.
Long-term capital gains -- i.e., gains on investments held for over a year -- are taxed at much lower rates than ordinary income, and for some tax brackets, they aren't taxed at all.
On the other hand, short-term capital gains are taxed at the same rate as your marginal tax bracket. So if you're in the 28% tax bracket and sell a stock at a profit of $5,000, the length of time you held that stock can make the difference between $750 and $1,400 in capital gains tax.
|Marginal Tax Rate||Short-Term Capital Gains Rate||Long-Term Capital Gains Rate|
Additionally, if you have any losing positions you may want to get rid of, the IRS lets you use investment losses to reduce your taxable capital gains. If you didn't have any gains for the year, you can use up to $3,000 worth of investment losses to reduce your taxable income. Any amount above $3,000 can be carried over to the next year, so selling losing investments could boost your tax refund next year.
Avoid selling promising long-term holdings
Also consider the reasons you bought your stocks in the first place. Did you buy them because you thought they had long-term growth potential or because they offered safety and income? Stocks in the latter category make the better candidates for a sale.
Basically, when you buy a safe dividend stock, such as Johnson & Johnson (NYSE:JNJ) or Procter & Gamble (NYSE:PG), the share price doesn't fluctuate tremendously. So there's a good chance you'll eventually be able to buy those shares back without paying several times what you sold them for.
With fast-growing stocks, there's no such guarantee. I learned this the hard way when I sold 100 shares of Tesla Motors (NASDAQ:TSLA) at about $50 each to help pay for my wedding (true story). By the time I had enough money to buy those shares back, it was too late -- the share price and the valuation had skyrocketed.
But can't I buy a home for 3% down?
Homeownership can be a better deal than renting if you do it right. There are low-down-payment programs you can use if you don't have a lot of money to put down -- but they're expensive.
For example, through the Federal Housing Administration's mortgage programs, buyers can purchase a home for as little as 3.5% down. Fannie Mae and Freddie Mac both recently announced 3% down payment conventional loan programs for first-time buyers.
However, consider that the added cost of mortgage insurance, combined with the higher loan balance, could combine to produce a monthly payment that's more expensive than rent would be. The monthly payment on a 30-year mortgage for a $250,000 house at 4% interest would be about $1,336 with an FHA loan (assuming 3.5% down), even with the newly reduced mortgage insurance rates. A conventional loan with 20% down would come with a much more affordable $836 monthly payment.
So it may be a solid long-term financial decision to sell stock to raise the funds for a larger down payment. Just keep taxes, urgency, and the type of stock in mind when you do it.