Save Towards House Down Payment or Retirement?

If you know you need a big house downpayment in a year for a $500,000 house, do you:

A) Totally minimize your retirement contributions (just get your 401k match if any), and save everything else towards that downpayment, knowing at best you’ll get about 20% down?

B) Plan to save enough so that you’ll get at least 10% down (enough for a 80/10/10 loan), but put the rest away in tax-deferred accounts?

I’m shifting towards B, as I just don’t know if I want to have so much of our net worth tied up in a house. This way, I have a more balanced distribution as well as more money tucked away to grow until retirement. But then again, I’ll probably have to pay a higher rate for the piggyback loan or PMI. Thoughts?

Comments

  1. Jonathan, I like what you have done with the formatting of the comments.

    As for this post, I would go with plan B too. If it were me, I’d porbably put around 15% just because I hate big loans. But your interest is tax deductable and putting money away will also lower your tax burden. I’m not sure what an 80/10/10 loan is so I dont know how that plays into it.

  2. Jane Dough says:

    You are 27 right? And you say you plan to buy in one year? I would recommend plan A. Frankly you can never have too much savings when entering into the house buying process. If you can reach the 20% goal then you should certainly shoot for it. However, you do realize you will need more than 20% in cash? You also have to figure in the cost of the mortgage loan itself (fees and possibly points). You may have to pay the seller back for pre-paid taxes which could add up. You need to pay to move. Then their are unexpected things that crop up once you own the house – cost to paint rooms, curtains, rugs, etc. Sometimes silly things you never thought of cause you to spend money – only had 1 bathroom in your rental but now have purchased a 2.5 bath house? Better plan on spending for more towels, shower curtains, etc. Also, your mortgage company is not going to want to see you drain your cash accounts to give them 20% down. They will want to see you have sufficient cash left in your accounts after paying the downpayment to deal with any unplanned expenses that could crop up.

    But enough about the expenses. Pulling back on retirement savings for one year while still in your 20′s for a goal as admirable as purchasing a (hopefully) appreciating asset – a home, is a good move. You have plenty of time to makeup for the year-long lower retirement savings rate.

  3. Open excel, run the numbers, see what the impact is to a) your net worth b) your risk tolerance. Provide us the answers and we can provide some insightful and possibly sarcastic commentary.

  4. C) Buy a more inexpensive house? ;)

    I would probably go with A) because I hate being tied to a big mortgage payment and I try to carry only as much debt as is necessary.

  5. Hey Jonathan, I have heard quite a bit about prepaying PMI and it appears to be a way to go if you have to do PMI. So if you are doing PMI, roll it into the loan and pay it up front. I still have lots of research to do on this one, so please do your own research also.

    However, I think if you can do the 20% down, that is the way to go. Your house will grow in value like your retirement and when you sell it, it could be tax free also using your one time exemption, up to $500,000 for you and your wife.

  6. I sent you an email, because there are credit unions that even with only 3% down don’t require PMI without a catch. My credit union for instance has free biweekly, interest bearing escrow and with only 3% down PMI isn’t required and one of the best rates around.
    You’ll probably get a bunch of different opinions on the subject, but even though lately the national average of real estate has increased substantially, historically it’s only been 5.1%.
    I think you need more information to figure out what?s in your best interest. Such as how much are you paying for rent now and buying the house, how much of your mortgage will apply towards principle, plus the interest that?s tax deductible.
    Even though you are looking for half a million dollar house, a lot of people recommend only borrowing up to 3 times your total combined income. There was actually a post on the Diehard forum awhile ago about a person who was going to purchase something that was 6 times their salary and most agreed that anything over 4 times is just crazy. I?ve always heard the value 3 times your salary as a rough estimate.
    I just give my opinion I?d probably go with B, but go with 90/10 without PMI instead of the creative 80/10/10.

  7. The challenge is, at least in the cities I want to live in, that often times you have no choice about what % you put down – 20% is usually mandatory.

    I will say that I’ve toyed with option A for a while. My fear is that I will get used to the seemingly increased income, and have a hard time racheting back up our 401K contributions once we’ve purchased the house.

  8. We are currently trying to make the same decision. For us, I think we are going to go with the ‘save 20%’ for a couple of reasons.

    One, we will not get an employee match until after 1 year of service for our retirement. Second, we figure that the 2nd loan or PMI would most likely be in the range of 7-8%, and we would rather try to avoid this high interest rate plus get a lower one by having the 20% down payment available. Finally, we would like to lower our monthly payment as much as possible to allow the flexibility for 1 of us to stay home with children that most certainly will follow shortly after this purchase.

    May not be the best ‘financial’ decision, but some decisions require emotional and risk factors to be help make the decision; and these factors are often difficult to calculate into numbers. We look forward to reading others reply and to hear more of your decision.

    -Medicated

  9. My thoughts on this topic is also (B) However, I would place the money in a specific mutual fund 17%+ (small to midcap growth) instead of in your HSBC bank yielding 5%. On top of that, bring down the 401K contributions to matching status with your company.

    Make sure you max out your RothIRA. Tax free withdraws later is way better than 401k withdraws.

  10. Although 20% would be nice, it is really not necessary. If you can qualify for an 80/10 and put 10% down on a $500,000 house you are still doing great. The 10% should be enough of a cushion if you need to sell the home within the first few years, and you will be able to diversify the other $50,000 in other ventures. Guessing from your previous posts, you will benefit greatly from the tax savings from the interest you are paying on the extra $50,000 you will have financed on the 10% loan.

    You can always pay the 10% loan off with the extra you planned on saving and get the benefits of owning a home now.

  11. Oh, I left something out. That’s what happens when you write at 5am in the morning. Both of our incomes will increase in a year, most likely in the $150,000 annually range. I know that may change things.

    “You?ll probably get a bunch of different opinions on the subject, but even though lately the national average of real estate has increased substantially, historically it?s only been 5.1%.”

    I thought about that, but that’s a leveraged 5.1%, isn’t it? Regardless of downpayment or equity, an appreciation of 5% of $500,000 is $25,000 just the first year? Of course for an average you must keep the house for a long time, which we also plan to do.

  12. Save whatever you need to get a house and do not be deterred by anything–i.e. 401k etc. Your 401k is not that great if your home is not paid off when you retire. Please note, your home value grows tax free too (currently $500k if married). A $500k home now will be worth approx. $1.5m in 30 years.

  13. J,

    I thought about that, but that?s a leveraged 5.1%, isn?t it? Regardless of downpayment or equity, an appreciation of 5% of $500,000 is $25,000 just the first year?

    That’s 5.1% on the home less the interest. If your 500k home has a mortgage of 400k, then it’s about 400k x 6.5% – 5.1% x 500k for the first year. About net 0 the first year.

    I think when it comes to home mortgages it’s really a comfort factor – how small of a fixed payment do you want? If you put down 10%, will you always maintain a 10% equity position, e.g. take a HELOC in good appreciation times and pay down principal in bad appreciation times? Or, is your goal to pay down the mortgage ASAP?

    From a non-emotional standpoint, look at it from a net worth standpoint – put down as little as you can to qualify for the best rate compared with your other investments.

    -Wes

  14. Don’t get me wrong I love real estate and even 5.1%, which I don’t beileve the number is leverage I think is a good deal. But regardless if it’s compared to renting, more of your money can go towards principle. You’ll get back some more money for the intrest on taxes, plus if you take care of your own escrow you can put your house insurance and possibly your taxes on your 2% back card, which is just more money going towards you.
    I wouldn’t do the 80/10/10 though, but look for better lenders. Most lenders even require 20% for you to take care of your own escrow, but shop around. I know two credit unions that don’t require PMI with 3% down, but they are difficult to get into. I was at another board were a girl wrote she’s going with ING as they don’t require PMI, but they only have arm loans. PMI in my mind is way too expensive and I’m not a big fan of 80/10/10 when you can take other alternatives.

    Looks like you aren’t over doing yourself either with 150k, looking for a 500k. The recommendation as I wrote earlier would be 3 times, so around 450 borrowed would be nice.
    Keep us updated on your choice

  15. Note, the risk of your net worth is not the real question. The question is your asset allocation risk. You will have as your assets $500,000 home. The question is this too large of a portion of your assets (too risky if all your eggs are in one basket – like you referred to). Yet, the difference in having 100% or 90% of your assets in your home (looking just at $500,000 home or $500,000 home and $50,000 in 401(k)) is not the real decision – both are risky unless you have other assets. Some have pointed to allocating your assets based on net worth (e.g., $100,000 in real estate and $50,000 in 401(k)) may not sound bad. Yet, if you have $500,000 home and $400,000 mortgage, your allocation is $500,000 home and $50,000 401(k)).

    Note, your home is not as stable of an asset as people believe. Look at the risks that regular home insurance does not cover (e.g., flood, earthquake, termite, landslide, etc.). Home can be a good investment, just make sure you are aware of the risks.

    Lastly, the real question that you asked is would I rather have:

    a) Larger 401(k) balance or

    b) a smaller loan.

    This is a question of risk and return on your investment. Do you believe you can get a better return from mutual fund than a guaranteed return from paying off your mortgage and avoiding PMI (or variable interest rates with a home equity loan for the loan to get to 80% base mortgage to avoid PMI).

    I wrote about the risk versus return issue a bit at:
    http://www.myfinancialawareness.com/Topics%20Financial/
    Should%20I%20have%20a%20Mortgage.htm

  16. We are in the same boat – we’re planning to buy a house in next 1-2 years. Besides what other people have already said, I’d like to add following:

    1) If you are 2 people earning and the lower earner at least brings home money equal to your monthly payments, then I think you’ll do just fine with option A.

    2) Personally I hate paying interest and PMI is just worse than even interest. If you have substantial 401k savings (say 50k) and plan on sticking to the same employer for at least 2 more years, it is probably safe to get 25k loan from your 401k itself, that would go towards 20% of downpayment. No matter what interest you pay on that loan (generally ~7%) you’re paying yourself. Also some experts comments that you’ll be double taxed on that money is just shallow in my opinion – if you’re clever you’ll figure out you’re going to be double taxed anyway on the secondary loan.

    3) One more important thing – even 5% appreciation in today’s market should not be taken for granted. In New Jersey suburbs of NY, I’ve seen list price of houses coming down by 25K since it is a somewhat buyer’s market there now (I guess). Also dont forget the 1-1.5% tax you need to pay on your house (in NJ you’ve to pay ~8.5K for the kind of house you’re looking). So if prices even stay at where they are (dont appreciate/depreciate) you’re losing 1.5% in house tax.

    All the above points are my actual situation. So if someone can point to flaws in above reasoning or tell me something that I’ve not considered, would be very helpful.

    Again – I’m from 2 income family aged at 30, planning to buy house in next 1 year. I only have 20% downpayment, if I liqudate all my shares, take 50% loan from my 401k etc. But I’m still inclined towards making down payment of 20%.

  17. bigmouth says:

    Jonathan,

    I believe you can probably reach both A and B is you plan ahead and find other avenues of income (even if those are borrowed from your folks.)

    To me, it’s silly to not make the 20% down while you have the ability to. Especially when your retirement is still about 25-35 years away. Your fortune may change dramatically during this 25-35 years and your current investment portfolio and retirement contributions maybe completely irrelevent by then. Your house is not, however, a speculative propersition. It’s there and you are in it.

    80/(10/10) is really just a creative accounting for those people who can barely come up with 10% of interest rate and want to avoid the huge PMI. From my understanding of your situation, you should be able to make 20% without having to give up most of your retirement plan.

    At last, half million dollar home as a starter home? You should rethink about it. You don’t even have a child yet. What do you need a 2,500-3,000 sq. ft. house for?

  18. “At last, half million dollar home as a starter home? You should rethink about it. You don?t even have a child yet. What do you need a 2,500-3,000 sq. ft. house for?”

    500k buys about 1,500 sq ft or less actually where I am looking.

    And yes, I could easily look elsewhere, but some things are more important than money, like having your kids grow up with their grandparents.

  19. After re-reading the comments, I see a variety of viewpoints.

    “From a non-emotional standpoint, look at it from a net worth standpoint – put down as little as you can to qualify for the best rate compared with your other investments.”

    “This is a question of risk and return on your investment. Do you believe you can get a better return from mutual fund than a guaranteed return from paying off your mortgage and avoiding PMI (or variable interest rates with a home equity loan for the loan to get to 80% base mortgage to avoid PMI).”

    I think these two statements pretty much sum my current view. If a bank will let me get a 10% down loan with no PMI (which is what I thought an 80/10/10 was – 10% down, 10% piggyback loan on the 10% down, and 80% financed), then I’ll probably go for it assuming the rate is reasonable. If the rate stinks or I have to pay PMI, I’d want to go for 20% down to get a good longterm rate.

    I’m not going to be the type to plow everything into paying off the house necessarily if the rate is good, as I think stocks will outperform in the long run.

  20. We have an 80/20 with no PMI or Escrow. No PMI b/c of the 20% loan and no escrow because of our credit. I recommend to skip the escrow account if you can since you are obviously good at managing your money.

    Thanks to you we found Emigrant Direct at 4.65% (now at 5.15%)! I just estimated the yearly insurance and taxes, devide by 52 and have a weekly draft to our savings instead of escrow. I would rather make 5.15% on my money and know it is being done right.

    I had heard too many horror stories about screwed up escrow accounts to let it happen to me.

  21. bigmouth says:

    Johnathen,

    People are paying more to their mortagages not because simply because they want “to plow everything into pay off the house…”

    20% or more down has a very distinctive advantage: you build some equity up front. If you do 80/10/10, you build very little equity in the few few years. If the house doesn’t appreciate naturally (as this is the case in some markets), then you may get into a situation where you will lose money if you want to sell the house for whatever the reason.

    If you don’t make money on your house (accumulate some equity), then you are just paying a big fat rent anyways. I’ve seen several people end up that way when they had to sell homes due to relocation needs.

  22. FWIW, I got an 80/15/5. I had very little saved up in my 401k. I had to ask my family for a gift to make the down payment and the closing costs. I think you are better off with option B because you will still be saving in your tax deferred accounts (which you don’t get an opportunity to do again when the year passes), and you’ll still be getting a home.

    Yes, you may get a better fixed rate with a traditional 80/20 loan, but you can usually avoid PMI with a 80/10/10 and what’s just as important is that you can write off the mortgage interest on 90% of your home and so there is additional tax benefit there on option B which does not exist with option A.

    It sounds like in a year you will be able to pre-pay your mortgage and so your 2nd trust of 10% will probably vanish in 2-4 years if you and your wife are diligent about paying it off.

    Good luck!

  23. Your instinct in going with B) is good. No need to tie up the money in the house. Maximize on 401k contribution to lower your tax payment, and use the interest payment to furhter lower your tax liability to uncle Sam. Your future income will more then able to support the mortgage payment. You are also young and smart, and likely move to another house in 5-10 years as well as able to get better return with the money that you set aside.

  24. hi,
    i’m a college student and don’t know much about buying a house, so can someone please tell me what an escrow account is/does?

  25. Run the numbers and see which has the greatest positive impact on your net worth.

    If you spend more on the house downpayment, you could lose investment returns and save on interest.

    If you go the other way, you make more investment returns (and tax savings) but you pay more interest.

    Also consider the housing market you’re buying into, the additional costs with owning a house, etc, etc, etc, etc.

    If have a VERY detailed financial spreadsheet I use for this purpose and with the Seattle housing market the way it is, I’m just hanging back for now, putting money into retirement and taxable accounts and waiting for the right moment to pull the trigger.

    -M

  26. After some more thought, I think Jane’s point is strong. Having more than 10% can’t hurt, and I should be able to put whatever I don’t use into a 401k next year anyways. So I think I’m going to focus on just growing the cash hoard for the next year.

  27. BigMouth said:

    20% or more down has a very distinctive advantage: you build some equity up front. If you do 80/10/10, you build very little equity in the few few years. If the house doesn?t appreciate naturally (as this is the case in some markets), then you may get into a situation where you will lose money if you want to sell the house for whatever the reason.

    If your finances are that skinny where you have to worry about that then you are probably buy too much of a house for your financial situation. There is no difference between “savings in the bank” and “equity” except your equity is tied up in real estate and your “savings” can be in whichever asset class you choose.

    -Wes

  28. With the current interest rate (6.5-7%+ depending on your credit score), if you pay more to the downpayment, you basically get a RISK-FREE return of that 6.5-7% over the next 30 years (if it’s a 30-year fixed). I’m not sure if the stock market can yield much more than that in the next couple decades…

    Yes, mortgage interest is tax deductible but don’t forget capital gain is also taxable in a tax-deferred account.

    IMO, I’ll go with a).

    Or, maybe c) if your parents can lend you a loan with a lower interest rate.

  29. One last thought – you have good credit and a lot of mortgage lenders would probably LOVE to have you as their customer. So, shop around.

    One option my husband and I found was the ability to “recast” our loan. If we make a principal-only payment of $5,000 or more, we can decrease our monthly payment. Given our balance and interest rate, it only decreases it by (about) $30/month. But, hey, it’s better than nothing.

    Note that if you choose to recast your mortgage, you don’t decrease the term (length of time) of the loan, just the monthly payment you make each month.

  30. Understanding that you’re not looking to buy for a year, here are my 2 cents:
    1) Learn the market now; know what homes have sold for in the market, and know what people are asking for those up for sale.
    2) Save as much as you can as quickly as you can, and if this means not putting a dime into your 401k (ONLY temporarily), then so be it.
    3) Investigate mortgage brokers/lenders, pick one, and get pre-approved now.
    4) Do your own house-hunting research.
    5) Interview real estate agents–I’d avoid those from national “chains”–and find one willing to act as a buyer’s agent for a flat-fee ($1000 is reasonable) should you want to make an offer on a home listed with an agent. *Be sure this agreement exempts you from using them should you want to make an offer on a For Sale By Owner (FSBO) property.
    6) See a lot of houses. Make a date on Sunday afternoons and tour open houses.
    7) In my experience people grossly overestimate their homes’ value, so I’ve found FSBO properties to not be great deals, though there are always exceptions.
    8) It’s almost impossible with your first house, but remember this is an investment. TRY to keep emotion out of the equation during the purchase transaction or you may pay more than you should.
    9) I have a rule: never pay retail. It may be difficult in your area, but deals can be found.
    10) If you’ve done #1, 2, and 3, and find a great deal on a house next month, make an offer. If you find a home at 15% off of FMV and have 5% down, you can immediately refinance whatever loans you’ve used to get the house in your name and do a traditional 80% mortgage based upon the appraised FMV. You’ll come out ahead financially vs. waiting a year and *hoping* you find a good deal.

  31. Jonathan, I agree with Jane and plan A. Get the match, and sock the rest away for the down payment. I think your timing in buying will be great as within the next year home prices in the Bay Area *will* (hopefully) go even lower. I have already seen reductions to the amount of $40k in neighborhoods I track. But these are to prices that are already very inflated. I dont know if you have looked at any houses here and specifically which areas, but I find it hard to find any houses for $500k unless you are thinking condos/townhomes.

  32. Bigmouth says:

    Wes,

    Although equity is calculated as part of your network, it is not the same as cash in the bank. Most people never use equity to do things similar as cash. Instead, equity will be served for one or two purposes:

    1- build equity towards your next house (hopefully bigger and better and more downpayments/less mortgage)
    2- convert to home equity loan for home improvement, which in trun increases your house’s value (equity)

    This concept is very important because it is very similar to that of retirement fund. You don’t touch it until you have an empty nest and start to down size.

  33. Unless the terms are awful, I would never put more down on a house than the minimum I could get away with. Our first house was an FHA loan, which I think was a 5% down payment. The second house we financed with a 75% first, 15% second – and we kept most of the profit that we made on the first house.

    The reason for this is simple – it’s easy to pay extra towards the mortgage if you have the money; it’s not easy to get the money out of the house if you need it for an emergency.

    We’ve lived in this house for 15 years, and it’s more than doubled in value, but if we moved I’d probably finance the next house to the limit of what we could afford in payments. But it’s funny – we’ve refinanced a couple times, and I’d never take equity out on a refinance.

  34. Bigmouth,
    You are right, equity is not the same as cash in the bank but it is part of your net worth just like the rest of your portfolio and should be treated as such. When you need cash for something you need to look at your whole portfolio and examine the opportunity costs of your various resources.

    Your house is a home, but it’s also an investment vehicle, one that has an impact on your net worth.

    Wes

  35. Would you take out a loan to invest in your retirement? Of course not, but that is essentially what you are doing if you pick A or B. Stop your retirement contributions until you pay off your house. No debt should be your ultimate goal. Reach that and it will be amazing how great it feels and how easy it will be to reach your retirement goal.

    I didn’t have a chance to read all the comments, so I apoligise if this has already been said.

  36. “Would you take out a loan to invest in your retirement? Of course not, but that is essentially what you are doing if you pick A or B. Stop your retirement contributions until you pay off your house. No debt should be your ultimate goal. Reach that and it will be amazing how great it feels and how easy it will be to reach your retirement goal.”

    I think this is getting back to the popular pay down mortgage vs. retirement quandry.

    If I could get a 6% 30-year unsecured loan with tax deductible interest, yes. Somebody else put it like this – would you buy stocks on a ~4.5% margin? If I had 30-years, yes I think stocks will outperform by a lot. But I can also totally understand why people would not want to do this.

  37. You should go with option B).

    As others have pointed out you can deduct the interest on both loans.

    You will have other expenses crop up during/after you buy. So if you have put all of your money into the downpayment you will have nothing to use for the unexpected expenses. (I’m sure you wouldn’t use all of your money, but you may not want to cash out of other savings/stocks in order to pay the bills)

    You can easily pay off the second mortgage quickly( I believe it took 2 years for me to pay mine off). Or you can refiance in a couple of years if the house has appreciated substantially and roll the 2nd mortgage into just one loan.

    Do not take out a loan on your 401k as someone suggested and do not defer putting as much as you can into it. You will(hopefully) be making a better return in your 401 than you will be paying in interest.

    Just my 2 cents.

  38. I think for you, this question boils down to your risk tolerance and plan of action for short-term halts to income (i.e., being laid off)? If you put more money down, your monthly payments will be lower, and then your discretionary saving in such an event could easily be redirected to paying bills until the income stream comes back…if you choose 401(k), you can borrow off that in case of emergency as well — it’s just not quite as liquid.

  39. A little off topic, but something I’ve been wondering about since we just bought a house….. is it in any way possible to work out a way to pay your mortgage through a credit card to get 1% back?

  40. Susannah says:

    I know some people are dead-set against this for any reason, but wouldn’t this be a good scenario for considering borrowing money out of your 401k? Instead of just putting it into cash savings, you can go ahead and get it into the 401k, then borrow it when you need it, and most likely it will be at a cheaper interest rate than any 10% loan you will be able to get along with your 80% loan. It just seems to me that would be a better option than option A, which seems to be what you are leaning toward at the moment.

  41. Texas Grad says:

    No one can tell you what is correct; you have to decide what type of risk you want to take. I will tell you what I did last year when I bought my first place – it may or may not be applicable to your situation.

    I graduated undergrad in 2004 and moved home with my parents to save some cash. I purchased a 1,200 sf condo in the Galleria Area of Houston in the summer of 2005 for ~$130,000. I had been contributing up to the match in my 401K since starting work and I had barely enough cash to put 20% down. I decided putting 20% down wasn’t right for me because it left me with very little non-retirement assets in case of emergency.

    When I say emergency most people think of job loss, but don’t forget long term illness or injury, car wreck, or anything totally unexpected that prevents you from working. My company provides short term and long term disability insurance, but even that wouldn’t be enough to live on while medical bills are rolling in.

    I chose an 80/10/10 loan to avoid escrow. The 10% loan is a 15 year loan amortized over 30 years. That means the payments are calculated as a 30 year loan but the loan is due in full in 15 years (balloon payment). This gives me the flexibility of a low monthly payment and lower interest payments while I pay it off early. I am paying 6.5% on the 10% loan, which is only 1% more than my 80% loan. I don’t rely on my year end bonus to live so I use that plus regular extra payments to pay off the 10% early. I will have the loan paid off by end of year and will either add my payments which I will stop paying to my savings or my 80% loan to pay it off early.

    Sorry for the long post, but that is what I decided and why. Comment and or use it as you see fit.

  42. I just have two points to make:

    1) Depending where you live 500,000 could be a condo. The median house price in San Jose, CA is around 650,000. This will get you an 1100 square foot shack.

    2) Everyone is looking at all the positive of buying. Most likely appreciation will be negative after inflation for the next few years. This means renting and saving might be a better option depending on location. However, who really knows…

    Here is a map of how over priced the market is right now:
    http://graphics10.nytimes.com/images/2006/08/26/weekinreview/27leon_graph2.large.gif

    Here is a website I find interesting with a rather negative outlook on the housing market:
    http://www.patrick.net/housing/crash.html

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