…I’m in the position to pay the house we want in full using the cash reserves my wife and I saved up. Do you think I should get a mortgage anyway and put money to work by investing or do you think it’s better to skip the whole mortgage process? Do you think you can relay the question to your readers to get their take?
Adam sent me an email with this question the other day. Through some unusually fortunate events, his family has the luxury of deciding whether they even want a mortgage. He needs our help, and here’s what I think.
Pay in cash.
Happiness has little to do with money, and the former is much more important. High net worth is great, but trying to maximize a number can only turn into a disaster. You can always leverage your mortgage and invest for a potentially higher gain, but that’s a stressful game to play. Like I keep saying, you may not strike it big by paying your mortgage early, but no one is poor being debt free.
Additionally, here are a few more reasons why paying cash is a good idea.
- Cash Offers Rule – In the current market, getting a loan represent a huge unknown for a seller. If I were to buy a house today, the bank can reject my loan because of the selling price, my credit or my loan amount (among many other factors). If I have cash, the seller has the comfort in knowing that the deal has a much higher chance of going through. Therefore, a cash offer with a lower price may even be accepted despite competing against other higher offers. In other words, I can offer less for a house if I can pay for it with 100% cash. Don’t believe me? Talk to a trusted real estate agent. Cash offers are winning in your area too.
- Mortgage Fees – If you are getting a mortgage, expect to pay around $5,000 at closing. If you pay cash, expect to pay half or less, plus you save yourself from all the hassle that your mortgage lender will give you during that 30 days or so.
- Buying a More Modest House – “I buy because I can.” There’s too many reasons we want to buy a bigger home, and having significant cash plus a mortgage is just going to increase the odds that you will buy a unnecessarily big house. Paying cash puts a cap on the home you can afford, which is not bad at all.
It’s worth noting that too many people make the mistake of putting everything they’ve ever saved to buy the house. Remember that you still need to buy furniture and have a sizable chunk of savings left in case of emergencies.
Pay cash if you can, but never go all in.
This is what I think, but what about you? It’s completely okay to disagree (in fact, it’s great if you offer a different perspective). Adam needs your help, so let him know your thoughts.
{ read the comments below or add one }
After four years into a mortgage? I am finally at a financial position where I have just enough to pay off the remaining principal of my mortgage. I feel quite a relief mentally even though I know I still need to do more financially. Looking back in time? I have been paying extral towards the mortgage very aggressively. It is not an understatement to say that I have been house poor for the past four years. However? I totally feel it is worthy of the effort. All in all?I support the idea of paying down and off mortgage as quickly as possible even if it meant to live frugally and below my means.
If you have the cash to pay for the house without utilizing a mortgage , pay it all off at closing. It is that simple and you will enjoy a great sense of security and peace of mind. If you need a mortgage for the purchase transaction to go through, then you will have to decide how much of your own cash you want to retain after the transaction. I personally put up as much as possible from my own savings leaving only some emergency funds in the bank. People tend to argue that instead of using one’s own cash, one should borrow for the house, and invest the extra cash on hand and earn some returns greater than the interest rate on the mortgage. The assumption/flaw with this argument is that one needs to be capable of producing the returns, and also the in producing the return, there is risk associate with it. It is not as easy. That is why I prefer paying off the debt/mortgage as quickly as possible and have a peace of mind.
I don’t make a lot of money (37k) and don’t have good credit, but I inherited some money when my Grandmother passed away and I didn’t want to blow it so I bought a bank owned 3/2 ranch home in 2010 for 85,000 in Florida. I was eligible for and got the $8,000 tax credit. My girlfriend and I already had cars paid for with cash and we have no credit cards or any debt. So the only expenses we have to pay to live in the house are home insurance, utilities and property taxes. That’s the good news. Whats not good is we don’t save or invest any money. You would think that we would since we no longer pay 900 in rent and have no mortgage but we just get by. The problem of course is that sooner or later there will be a major expense like the AC will fail or the roof will need to be redone. That being said, I have no regrets. I own my home outright and that is a feeling that can’t compare with anything else. With the lowest prices in years and no credit (because I pay for everything in cash), this was my one shot at home ownership and I grabbed it. I think the point is if you can own your home outright you should because there is a value in that that can’t be calculated.
Indeed the entire 363k will be the benefit, since the annuity been taken are already accounting the payments being made.
Andy, while I agree with you that I have omitted a large and important data into the equation, I still believe that having mortgage at the current rates is much more beneficial than paying cash for it up front.
To simplify I will again use the same numbers as in my previous post, but this time will include the omitted information. For simplicity, I will omit the tax benefits since their effect works in favor of the same suggestion that I am making.
As is in our case, we assume that we have 200k at the time of purchase and we are buying 200k house. Now I will include 20% down payment as to eliminate PMI payments out of the equation, and 4k non escrow related closing cost, or as I refer it: true closing cost.
All in all we are left with 156k cash amount at the time of closing. In order to include the important suggestion that you made about the cash flow, we will perceive those 156K as a balanced investment with 7% annual rate of return, and annuities which will have monthly withdrawal equal to the monthly payment of the mortgage at 3.5% interest. So assuming a starting amount of 156k, monthly withdrawal of $700.51, after 30 years, you will have $363,090 in your account. During the mortgage, you will have paid $252,183. This leaves you with a positive amount of $110,907. Please note that this sum now factors in the cash inflow that I have missed in my initial analysis.
Imagine that you have an account with 156k at the time of closing, assume that you have this amount as a liquid 7% investment, and assumed that the above mentioned $700.51 withdrawn every month are being used for the mortgage payment. So after 30 years, you have $110,907 in this account. If you pay the amount cash, you account stats with 4k in saved closing costs, and assuming same 7% annual rate of return and ends with $30,449. Also note that those amounts are before considering the tax benefits of a mortgage. Depending your marginal tax brackets, the tax that you pay every year + the property tax your pay every year – the standard deduction times your marginal tax rate, would add additional number to this amount.
Andy, you mentioned that I am disregarding another large factor, being the peace of mind, and I think that exactly because I am considering the peace of mind, taking fixed low interest mortgage versus paying cash is much more beneficial, here it is why:
At the time of closing you have large amount of cash reserves that you don’t have if you pay cash.
The trend is that the standard of leaving is rising, thus we much more often have an inflation than a deflation, so in a long run the inflation offsets or at least partially mitigates the interest you paid on the house. You might contradict that the same thing apply to the cash you have left if you decided to obtain mortgage rather than paying cash, but the difference is that is much easier to convert and diversify this liquid cash to other revenue vehicles than trying to sell the house.
There is also an implications of your credit report as a longevity on a mortgage installment makes the person much more credit worthy and deepens the credit and raises the score of an applicant, who is to seek a business loan for an example.
Bongo’s entire analysis ignores the important reality that if you pay cash for your house, your monthly cash flow is larger by the after-tax value of whatever mortgage payment you are NOT making. These funds could obviously be invested to earn the same return he estimates could be earned in his scenario. So to suggest that the person who pays cash for a house will only have $200k (or whatever the house is sold for) when all is said and done is extremely misleading.
More generally, the decision to pay cash or sign a mortgage should be based on more than just dollars and cents. Non-financial considerations (like peace of mind) should not be ignored. And I have yet to hear anyone, in any circumstance or stage of life, wish they had more debt.
While all of those considerations sound reasonable, I want to add some more clarification. Rayan above mentioned that if you pay cash, you are not loosing the ability to invest since at the time of selling, you will have all of this cash back, but in this case the time value of money is being ignored.
Let say you have 200k and have mortgage and 3.5% interest rate on 30 yr fixed mortgage. Assuming that you have the funds available, by taking a mortgage, you will pay an average of 3-4k in closing fees that are directly related to obtaining the mortgage, not the escrow, since taxes on a house must be paid regardless. So let assume you pay those 4k fees up front, and you are left with 196k cash. Assuming you have balanced investment portfolio with average return in investment of 7%, the 196k you have left after the closing will net you $1,492,000 after 3 yrs. During the same time you will have paid in principal + interest $323,300. If you subtract this amount from your return over 30 yrs, your net amount is $1,168700. I will not even touch the tax benefit since it depends on your tax bracket, on the property taxes, in the adjustment of the Standard deduction, and diminishes over years, yet would still be some additional, yet for the purpose of this comparison, negligible benefit.
Lets now see the scenario where you don’t take mortgage and pay for the house cash. You pay house for the cash, 200k. You don’t have any obligations, and you don’t pay any interest. Assuming the value of the house stayed the same or slightly increased, you will have 200k cash by the end of 30 yrs. Please note that the gain or loss of the market value of the house should not be factored in, the gain or loss is independent of whether you pay cash or take mortgage. So at the end of the 30 yrs period, you will have 200k cash instead of $1,168,000 if you were to keep the money and take the mortgage. This is much simplified calculation, of course with mortgage, you would have had to put some money down, and depending of whether is 10% or 20% number of the amount invested would have been slightly lower as well as the interest, however the number would still have been much larger than 200k.
Let say you don’t want to invest the money and you instead have them under the mattress. Even in this scenario, the 123k interest you would pay over the life of the loan would be offset by the rate of the inflation, and slightly by the above mentioned taxed benefits compared to standard deduction. And yet, you would still have the opportunity to use the money for other purposes being opening business, emergency expenses, renovations, large purchases, etc.
So in my opinion, buying house for cash would only make since if it is a short term investment for a person that has much large excessive cash reserves, like a contractor who buys the house to renovate and sell for higher amount. In their case the cash purchase would make since due to avoidance of some closing costs.
For people who plan to live in their houses for prolonger period of time, and do not have large excessive cash reserves, having a mortgage at the current low rates is much more favorable approach.
I would calculate what the tax deduction on a mortgage loan is saving me, convert that to an interest rate and subtract it from the mortgage rate to get your actual interest rate. Compare that to the average return on a mixture of broad based bond and stock index funds at, say, Vanguard. If the recalculated mortgage rate is 2% or more lower compared to investing the money, then I would get a mortgage and not buy the house for cash. I would keep the loan to 15 years.
It’s not about trusting the banks. But the government should have rational rules (such as Glass-Steagal) to prevent such financial collapses. I blame the government, whose mandate is to provide for the “general welfare”to regulate the banks so they don’t use taxpayers to back up their risky gambles.
I demand that the government do its job. Since G-S was repealed in the 90’s and Bush then said hands off the banks (deregulation, lack of enforcment, the “Ownership Society (ie Debt Society)” etc). The banks are there to fleece us, but the government is there to protect us. The government failed, bailed out the banks, and left us hanging.
On the banks side, they should not be allowed to make political contributions to buy favorabable or lack of regulations.
Do I trust the government? That is not the question: the question is: does the govt have the duty to regulate banks to protect the public. And the Constitution says it does!
Dale,
It is not a case of trusting banks, they don’t want your trust only your money. Also, do not expect care or compassion as they do not deal in these commodities, only cold hard cash.
The American public bailed out the finance and banking sector. It seemed that it had to do so as the alternative was total collapse of the economy with tremendous results. It would also seem that they have not taken any notice of this narrow escape and are back to their old ways paying exorbitant salaries to their top executives, here in Australia one back, ANZ is paying it’s CEO in excess of $20,000,000 per year, it is unbelievable..
I am glad to know that you have a plan to forward with and I wish you all the success but please do not expect anything from the banks. Keep this thought in the fore front of your mind and you will not be caught again.
I am now 60 years old and from my experience and hindsight, it seems that we are all worse off the more we want to move house by selling and rebuying (as in getting a new mortgage each time). For an example, the house I got a mortgage on in 1981, meant that my mortgage was only $33,000 (my deposit was $10,000). So, a house worth $43,000 in 1981 is now worth $340,000 in today’s prices. Had I rented this house out to tenants and not sold it, and used their rent money to keep on paying off the $33,000 mortgage, I would have finished paying off that mortgage fully years ago and I would now have a fully owned house worth $340,000. Instead, I have had many moves over the years and now have a huge mortgage of $290,000 and a house that is worth $390,000 if I were to sell it. So because of all my selling and rebuying, I’m worse off by $240,000. Not good, but of course, I can’t go back in time and change things either. So in hindsight, I would say that to aim to own a house and NOT have a mortgage is a good idea, even if you are living somewhere else and paying rent.
Julie, we all lost in the big real estate rip off. I am 71, working full time to keep my home. I built it in 1990…refinanced several times only to improve it so that when I reached old age (ie now), I could sell it, take the equity, and downsize to a house I would own debt free. I have built my equity up for 45 years, buying and improving homes. My first home cost 6K and I sold it, after installing a toilet and roof, for 12K.
My current home was worth, in the inflated terms of the housing bubble, about 600k…so when I last refinanced 5 yrs ago, I figured I would really fix it up and resell when the mortgage exploded in 5 yrs. Five years later, I had lost all my equity as in my area, where the median house price hit 800K, it dropped 40% and in some cases, older homes are selling for 1/3 of the loan on them. So I have, after 45 yrs of fixing up old houses, building and developing a new house, got zero equity (like tens of millions). I have been criticized by those who did not understand that I expected a 20% drop in home prices, the most ever in our history, but not 40-50%.
I am paying the next 4 yrs interest only so I can, working, save up to buy a home I can own. I am making bids on two home in Arizona near my family, one for 52cash and one for 70K, so I will have a small debt I could pay off by working and saving one more year. These are fixers (but nice homes) but I have also fixed. There is no point taking my 55K cash and paying down my 360K loan……I am going to rent out the house, live in the nice studio next to it, just to pay the interest only mortgage and then, in 4 yrs sell it, as the market is going up fast in California (up 16% last year) and I might have regained some equity….a fund for my older age.
When one person gets burned in a bad deal, maybe it ‘s his fault; when everyone gets burned (like all Americans who have lost trillions, most harmful to the old and minorities), its the fault of the system. The banks and the laissez faire govt policies caused the bubble and the financial collapse.
We have all been burned, whether we bought new homes or just refinanced to increase the value of our existing homes. My home is beautiful, set in the redwoods on 2/3 acre, backing to a wilderness, with fruit trees and rock walls and winding paths and gorgeous views..but my plan, expecting 20% decline, failed because the crisis was the deepest in US housing history, affecting all of us.
The banks got bailed out, AIG got bailed out…but we did not. We got the short end of the stick. So even someone like me who did not buy and resell but merely improved their property got ripped off. I hope very soon to own a home in ARizona (near Sedona) without debt. I hope when I sell my current home in 4 years there will be some equity. But I will never trust the banks again.
@dale: Although I empathize with your situation, the banks, gov’t are not entirely to blame. You used your house as a piggy bank by borrowing on the equity time and again. You assumed housing prices would keep climbing to the sky and they don’t. This was not a wise decision on your part. I don’t care if millions of folks did the same thing you did. It doesn’t make them right. It just made all of you go down into poverty together.
You lost money on your housing because you kept buying and selling houses. Every time you did that you assumed more risk and that risk finally caught up with you. Your situation doesn’t apply to the original question in the blog. They are either paying cash for one house or they are getting a loan for one house. Their risk is minimal either way.
Good advice, Julie. Buy and never sell, unless you’re selling through a 1031 to flip that paid off property into another investment property. You’ll never pay capital gains taxes again 🙂
My two cents would be to pay 50% to 70% down and finance the rest through a 15 year mortgage at 2.8% (+/-) interest rate. Then invest the rest in the stock market. Say you make 8% return over the next 15 years, you’ll have a nice supplement to your 401K when the mortgage is paid for.
1. Pay cash and own your home – the security and peace of mind is priceless for you and your family – personal experience has taught me this and I will never again carry a mortgage
2. as stated over and over again in the comments (going back two years) life WILL throw you curve balls that will leave you stunned – again, personal experience (work injury leaving me without income for over three months – worker’s comp said no – my insurance said no – go figure)
3. Banks are not your friend – not ever ever ever
your choices in life will be based on your personal debt and once you’ve experienced the choices you can make without that saddle of debt, you will never go back
Scott said: If you pay cash and own your house outright no matter what happens to you or your family you will never, ever be kicked out of your home.
I paid off my mortgage but I am not under the illusion that I own my home. I rent it from the government in the form of property taxes. They will be just as happy as a bank to kick me out and sell it to someone else if I find myself unable to pay.
First define something.
Bad debt: debt we have to pay back with earned (salary, personal) income.
So, carrying any amount of bad debt is a form of enslavement.
Rich people carry good debt (debt someone else pays off for them), investment property that has net income…
Poor people invest in liabilities they are lead to believe are assets by people who are dumping liabilities (nobody sells an asset)…
Second.
Net Worth and equity are abstract concepts invented by the financial industry to help sell loans.
An asset is really defined by it’s income…
Example: My 3bd 2bth house has a net income of $300 a month = 300 x 12 x 7 = $25,200 after taxes…
It is really worth $25,200 after taxes…
But that doesn’t sell any loans…
I like alagna’s comments. There are two types of debt. Those that you pay off yourself, and those that others pay off for you. That, my friends, is what separates the wealthy from the middling class. I’ve bought 5 houses, I still own all of them, and I’ve never lived in a single one of them. It’s not the house you live in that will make you wealthy; it’s the houses you don’t live in that will make you wealthy.
Because in a few years, my mortgage will explode and I won’t be able to afford payments, I have been saving up and looking for a cheapie. I was about to bid on a 77K fixer, with a strong downpayment (35K) but my realtor told me that 5 offers of cash were already in and that it was pointless to even make an offer, as sellers prefer cash.
Therefore, the cash buyers are making it impossible for me to buy a cheap house so (I am 71 and working fulltime) I could pay down in a few years and retire into.
So yes pay cash if you have cash; the trouble is almost everyone has lost all or most of their equity, has been paying down credit card debt if they have extra cash……and so the minority who were not wiped out by the bursting of the housing bubble are in charge, leaving most people like me in the dust.
It’s likely that, after building equity for 45 years and losing it all in the recession, I will never be able to recover. When I refinanced I always used the money to improve my property (I built the house myself 22 years ago)….but the 250K equity I had built up is all gone. The banks now own most American homes…something Jefferson warned us about if the banks were not “crushed.”
Hello, grandpa unit!
This is great for the 1% who have enough cash to buy a house outright. But most of us cannot. The recent economic collapse destroyed trillions in equity (it destroyed the equity I had built up over 40 years) and left us without our “wealth” and in debt.
In my area, rich professionals are buying up many of the homes for cash. They do so as investments, while those who need a home are forced to seek a mortgage, with absurdly high standards.
If you have enough cash to buy a house, it really doesn’t matter whether you do so or take out a low interest mortgage. You are sittin pretty. The rest of us have been screwed. I am 71; I took out a series of refi loans to upgrade my property with the idea that in 5 yrs, I would sell it, take my equity, and buy a cheaper house for, yes, cash! No, I am stuck with an exploding mortgage and no equity at all. I will probably go in with my daughter to co-sign on a loan for a house with a grandpa unit….tho I have gone back to work not to lose my house, and have saved 40K in the past 2 years, I am still dependent on the banks to put a roof over my head.
When a few fail, it is probably their poor decisions to blame. When everyone loses most or all of their equity, it is the system which is at fault.
The 40 hr work weeks are wearing me out, but I will still have to borrow to afford even a guest house with my daughter’s family. Me and tens of millions of Americans got screwed….and I can’t see anything to do about it except borrow again (I will never at 71 be able to pay off my360K mortgage) for a little shack in the backyard (I now live on a large property in the redwoods in a house I built myself).
That’s the way it is for most of us. We thought we were set, but the banks and the laissez-faire govt lack of regulations trapped tens of millions of us in debt peonage with no way out. I would welcome a Biblical Jubilee in which all debts are forgiven every 50 years. I don’t think the banks who own our government would go along. WE bailed them out but no one is bailing us out, even if we have made mortgage payments for over 45 years without once missing a payment and built our own house and used loans only to improve it.
Many homes locally (in a rich area) are selling at 30% of their mortgage debt.
Affluent professionals (doctors, etc) are buying up these homes for cash and will no doubt get richer as a result. Meanwhile, the rest of us are screwed.
Pay cash if you got it….current prices are a gift based on the destruction of trillions in family equity. It’s how the rich get richer.
I feel for you and would hate to be in your situation when I reach your age, but I think it’s unfair to place the entire blame on banks and government for the fact that after 40 years you still owe $360,000 on your home.
If you pay with cash or pay off quickly, you save an immense amount of money, especially when the balance is the highest. There are draw backs. Since most of your money may be tied up in your house, and you want to buy a different one, you have to sell yours or get a mortgage on the new one till yours sells. We are in that situation now. The market is bad and it is hard to move ahead to get a good deal. You now have to take a hit on your house if it will even sell. Any investment can be a gamble so it is hard to determine what the future will hold. There is something to be said for no debt. It does give you peace of mind. It is a scary thing to step back into the debt game, especially during these shaky economic times when the American dollar and economy is predicted to fail.
Keep this in mind: a mortgage is the bank investing in you. That means that when all is said and done, they make money from you, not vise versa. Not having a mortgage mean you keep the money they would have made. Buying a $250,000 dollar home is going to cost about $800,000+ over 30 years. That means you gave the bank over half a million dollars.
And even if you pay cash and don’t “invest” the half million, you already invested the $250,000 in the house instead of the bank doing so.
A number crunching exercise.This is only rounded out and theoretical,but plausible.$200,000 mortgage @ floating rate prime minus .3%=2.7%=$5400 simple interest.Invest the $200000 @5%=$10000 simple interest.You will pay tax on the income but a lot of that will be cancelled by a tax return on interest paid, based on income.Even if you come out ahead by an average $2000 year you are well ahead.You can then re-invest the $2000 for a compound return or use the surplus to make early payments to reduce the term.And you are still always gaining equity .You will end up with your house paid for and still have all your cash.But there is risk.
My take is this: If you pay cash and own your house outright no matter what happens to you or your family you will never, ever be kicked out of your home. That’s amazing security.
Here’s an idea nobody’s floated yet. Why not use the cash to buy the home at a discounted price, and then take out a loan on the house afterward at 4% and invest that money at a rate higher than 4%?
Or, one step further. Several people have mentioned the tax advantages of owning real estate, but the best advantages are reserved for landlords.
Let’s assume our friends have $250,000. Right now, they’re considering two options, paying for a $250K house with cash, and having no investments, or keeping $250K in investments, and paying a mortgage payment that would cost them roughly $1600/mo.
Why not get the best of both worlds? Instead of buying a $250K house with cash, buy a $1M 8-plex, paying 25% down. Then they can rent a home for themselves to live in for $1600/mo. The income from that 8-plex will net them roughly $1600/mo (assuming they get $200/mo in cash flow over the mortgage payment for each of the 8 tenants). So now, their personal housing costs are $0/mo, and they still have the four parts of Internal Rate of Return that favor real estate investors: 1. Amortization, 2. Appreciation, 3. Cashflow, and 4. Tax incentives. Once that 8-plex mortgage is paid off, they’ll be millionaires, having effectively leveraged that initial $250K, and once the mortgage is paid off, they’ll have retirement income from the rental property.
Where do they get the money to pay for the 75% of the $1M 8-plex and the interest thereof? Wouldn’t they kill themselves on the process trying to be “millionaires” in this manner? Kindly enlighten me, I am a bit confounded. Thank you.
Ron, those are great questions. The 75% of the loan comes from a bank. These are standard investor property loan terms (25% down, 75% carried by the bank). People think of DEBT as a bad thing. It’s only a bad thing if you use it to buy a ferrari, ethan allen furniture, or for your daughter to study art history at some small, nameless liberal arts college in new england. When somebody asks you if you want to purchase a $1 million dollar asset for a quarter of the price, you say YES! It’s like that line in Ghostbusters: “Ray, when someone asks you if you’re a God…you say YES!!!!”
The great thing about buying an 8-plex or so, is that the tenants pay the mortgage off for you. So, you have 8 families that are so grateful that you’re providing them a place to live, that they’ll willingly pay down your $750K mortgage every month. You don’t have to kill yourself doing anything. The bank gave you the $750K, and the tenants pay it down each month, and all you have to do is watch your principal balance on your loan go down every month.
It’s not buying or paying off the $1Million asset that’s hard; the only hard part is getting the $250K to start with. That’s why so many people never get there, they’ve never had the foresight that this family has to ACTUALLY pay off a $250K asset that they can flip into something more substantial. They didn’t sweat when the bank told them they had to pay a downpayment on the house they now own for $250K, so why would they sweat when a bank tells them they need to put a downpayment on a $1Million property. It’s the same concept, just a matter of scale. With the added benefit, as i mentioned, that once the 8 plex is paid off (by the tenants) you’re monthly retirement check (well, actually 8 checks) are waiting for you as your tenants pay you an inflation-adjusted rent every month.
There are tenants who do not pay. If you cannot make the mortgage without their $$, you will end up being a tenant.
I have a quandry as I approach retirement at the same time my 7 yr ARM is up. I have a surplus of funds above my retirement that I can use to pay off my mortgage completely plus I’d like to buy a Condo in FL. Should I refinance 50% of my home and use the other 50% for the second home in FL. Money is cheap now and pricing down in FL. Is it best to have primary residence paid off or balance the costs across both properties to have 50/50 on each. Seems I’d save closing /refi costs on the primary if I went full on a pay-off. Is it harder to get seond homes with 30-40% down?
Mathematically, it seems to make more sense if you just have one loan and use the extra cash from the first loan to get the second house. However, you are in effect putting more risk in your primary house if you do this as well because you just increased the chances that you might not be able to come up with the new payments in the future.
Whether that will change your decision or not will depend on what your finances are but with this approach, you are actually getting a bigger loan your primary house for the lower rate and using those funds to buy the condo. This way, you can deduct taxes from your mortgage and end up getting a better deal.
Right now, the housing market is great for a buyer but it’s better if you don’t.
In my opionion after listing to lots of experts the housing market hasn’t hit bottom yet. It would be better to rent and wait till the housing market stabilizes before buying. You would get the best deal and an opportunity to see if you can invest in a better interest paying investment. Maybe like gold stocks or ipod etc companies. Homes are not building equity at this time. You can’t sell them for even replacement value. Anyway, that’s my evalutation for what its worth.
Sure, the intrest on a mortgage is deductable, which serves as a reduction in rate – meaning that the real interest rate you pay in the long term is always lower than the one on your bill. That rate, however, will never reduce to 0%.
It is also true that the return on principle is 0%.
However a 0% investment is greater than any % of interest payment. That interest paid is a loss.
Now, if you invest the cash at a rate that is higher than the rate you are paying, you make money investing borrowed money, but you still have to buy that house (over 15, 20, or 30 years). Refinancing will cut your profits handily, so I will assume a normal mortgage.
The problem is, the money you invest will be depleated to pay the monthly mortgage bill or you will have to use your actual income to pay that bill. If you pull from the investment, you will see the initial profit dwindle to insignifigance quickly. A lot of work for a small margin.
If you pay the house off in cash, and then invest your income each month, you will sleep better at night, save yourself a lot of work and risk, and at most loose out on so little potential profit that you could have covered it mowing the neighbor’s grass for $10 a week.
we just purchased house me and my wife.
yes 25 years mortgage, as all have said here so far.
If I had the money to free in the mortgage tomorrow I’d do it.
I would not want to run around looking for investment.
Currently mortgage is just below 5% p.a so in case i’d need to beat that
well I need to earn 9-10% per anno. Does not seem alot i’d any day pay out mortgage first and then pay myself a mortgage “saving” of the same in the bank/bonds or similar pretending having a mortgage go for nice holidays, early retirements, upgrade on the house using my monthly saving..
We human’s are so easily fooled again and again,
tried the stock market myself earned 2 times the rest not
gave it up and started to save regular basis. no more foolish investments take the saves ones.
Cooledit
If you do the math you will realize that mortgaging your house forces you to pay three times the purchase price. The deduction for mortgage interest is nowhere worth what you actually pay in interest. People seem to forget that in order to write off the interest, first they must pay the interest. It’s a no brainer to me. Imagine the security of knowing that you have a ‘free’ roof over your head (except for taxes and insurance) for the rest of your life. Knowing that, no matter may happen to you financially in the future, you’ll probably be okay because you don’t have a mortgage. I worked my butt off and paid my house off in four years. Because of that and some mortgage free rental property (because we worked hard to pay those off as well), I and my husband were able to fully retire at age 45. PAY CASH for the house.
Thank you-that is exactly what I did. Just saving up cash for the investment properties now. That will be my retirement fund! I am 52 and do not have anything but S.S. & VA.
The numbers are in favor of keeping a mortgage and investing; however, one of the problems in the early ’30s was that people were borrowing money to put it in the market. Just because you use your house as collateral doesn’t make it different.
Housing is not an investment, it’s an expense. An investment is something you can do without and you aren’t going to do without housing. Plan like the money you spend on your house is gone. It might be there for your kids when *you* are gone, but don’t plan like you have this nest egg you are going to cash out.
Security, peace of mind, flexibility, and being able to decide what to do with your money each month are on the side of staying out of debt. We would have more money right now if we had kept our mortgage, but we switched to the no-debt plan and haven’t regretted it. If we had followed the conventional advice, we would still be looking at 18 years of mortgage payments. Yikes.
Anyone who says you should have a mortgage when you have the ability to own your house outright is either a “Financial Advisor” (I use the term loosly, they want you to be as leveraged as possible so they can reap more commissions, despite what the best interest for you is financially), or delusional.
I ignored the advice of my “financial advisor” when I ran the numbers of what I could expect a return to be in the stock markets vs. the real estate market in my area…and then promptly fired him. Furthermore, the “tax benefit” is not 100% of your interest. You’re still paying the bank interest…it’s a deduction not a tax credit, so you only get back the tax on the portion of your income that gets deducted.
I paid an enormous tax penalty when I cashed out my 401k to pay cash for my house in 2008…however…the tax penalty I paid was less than the cost of the interest I would have paid over a 15 year mortgage…much less than over the average 30 year mortgage.
As of right now, my house has even appreciated faster than the money left in the 401k. In just two years, I’ve completely broken even on the deal because I got the house for a bargain, and it’s appreciated nearly 80%.
Not to mention, if there is a real estate shock, and you have to sell a house you own outright, even if you lose money, your credit remains in tact.
Not only that, but owning my home outright gave me the ability to quit my full time job, pick up a part time job, and go back to school full time. If I had a $1400 per month mortgage on it, I would have not been able to do that right now. There is no question in my mind that owning your home outright gives you far more flexibility financially than having a mortgage.
Using 401k to pay for the house, an interesting point. But wondering how much extral income tax you paid for the year in addition to the 10% penalty…
Pay Cash by all means. After that I recommend assuming there is a regular income that you still make a mortgage payment-to yourself. Then invest that monthly payment you make so you earn a return on it. The reason I suggest this is so you earn for yourself what the bank would earn off of your 15 or 30 year mortgage note.
Another reason is something that happens to I believe at least half of adults in there lifetime. At some point we want to quote Johnny Paycheck. Especially in todays world where employers are constantly cutting expenses usually at the employees expense. In my case I have absolutely no debt other then my mortgage. If my mortgage was payed off I would not go back to work next Monday. I would walk away and take an early retirement. Then I would go work somewhere a lot less stressful. With no other debt I am able to make huge principal payments to my mortgage. but it will still be at least 3 more years before I get the nerve to say “take this job and shove it.”
Actual case: Cash talks.
I offered cash, as-is, on my last purchase. There were 5 other offers on this house. Without exception, EVERY offer was greater than mine, by at least $15,000, but none of the other offers was Cash.
I got the house. We closed in EIGHT days, as soon as the title search/insurance was done.
It’s what the seller needed – fast cash, and she was willing to take almost instant cash in lieu of waiting for someone’s credit to clear and all the loan papers to be drawn up.
As someone who was mortgage free after 3 1/2 years I can honestly say it was a life/marriage saver. You never know the curve balls life will throw at you. Pay cash for the house. Save an additional $10,000 or so for emergencies that may come up.
Here in Canada we have high tax rates, everything costs more and most don’t earn as much as you do in the states but if you don’t have to worry about a mortgage payment it is great. We have saved, invested etc. At times we’ve had to dip in but never had to get over our heads in debt because there was no mortgage payment. I realize interest on a mortgage is tax deductible in the states but how often do investors make the 8 – 10% in the stock market that they (experts) always tout. Not often when you count in the market corrections. Remember when you lose 40% you have to then earn 80% just to break back even etc.
I vote for buying the house with cash. That would be such a relief not having to worry about a mortgage payment.
I think it’s difficult NOT to have a mortgage, as nobody (or not many people) can save up $300,000 or more to buy a home outright. With that said, paying the mortgage off quickly (in 15 years or so) may allow you to retire early and save even more down the road.
See if you can use the cash option as a bargaining chip with the sellers.
Some friends of mine actually took a lower price and sold their house to someone for cash because they knew it was a “sure thing”.
As I’m trying to pay off my last bit of debt (mortgage), I’d do cash too.
If you are towards the end of your mortgage, then I recommend that you pay it all off. It’s nice to not have a mortgage. I pay extra principal towards my 30 year mortgage and hope to have it all paid off even before it’s 30 years later.
If you already have a mortgage I think it is even worse to sink extra money into it. You’re just helping the bank out. If something were to go wrong they’re going to say NO when you ask for your money back. In fact, they might say we need the house too.
I don’t think paying off your mortgage is helping the bank out. The bank makes the maximum amount of money if you don’t default and pay off your loans at the agreeable term.
It helps them if someone is in default but somehow is able to pay it off due to outside forces, but if the person were to pay it off eventually (ie, no default risk), the bank wants to keep them for as long as possible.
How do banks make money? By taking in $1 and lending out $0.97. The faster and more dollars they get the more money they make. The faster you give them money the more they have to lend out and make more money. They don’t want risk and they don’t want to foreclose. Foreclosures cost money. Banks want you to pay early and often.
By paying early, you are paying $0.98 instead of $1, so banks make less money in interest.
They don’t want risk, but someone who is paying in full later vs someone paying early carries the SAME risk.
Except that banks tend not to lend out loan income; they lend out money that’s on deposit. That’s why so many banks require that customers maintain minimum balances. Loan income, by and large, goes toward investments (the OTHER way banks make money) and paying out on interest-bearing accounts.
And here’s the thing: loan income comes from interest, not from principal. The faster you pay off a loan, the less interest you pay on it, and the less money the bank actually makes. No, the bank won’t mind if you pay early (as long as it’s not TOO early; that’s why a lot of loans have penalties if you pay them off before a certain amount of time has passed, generally 24 months), and yes, they want to avoid risk and foreclosure. But it’s in their interest for you to maintain your loan for close to the whole term, if not the whole term.
Paying extra each month doesn’t hurt the borrower; I’m confused as to why you seem to think that. It reduces the length of time that one is in debt; it reduces the amount ultimately paid; and, with most loans, it both advances your due date and reduces your next payment, which is a big help if you go through a few tight months. I’m also confused by this “if you ask for you money back” business. What exactly do you mean by that? Why on earth would someone go into a bank with all seriousness and say, “hey, you know that payment I made to my loan a few months ago? I could really use that cash now, so would you please give it back?” If anyone ever does that, they DESERVE to be told “no.” But even if someone does that, unless you default and can’t get out of it, the bank isn’t going to take your house just to spite you. And if you’re paying extra every month, and therefore getting ahead on payments, then you’re actually reducing the chances that you’ll default during difficult times.
Evolution of Wealth…. couldn’t agreee with you more… and if you need the deduction for mortgage interest where else are you going to get it but from your mortgage payments? With the downturn of the economy, I saw a young business woman lose her business and then the $750,000 inheritance she put down on her home. Even with so much equity in the house, her small mortgage payment was too muh for her to handle and so as you said, the bank was happy to take it all away from her.
Something else worth mentioning even if you pay everything in cash and have no money left for anything else. You can always open a home equity (HELOC) for emergency situations. Of course, don’t abuse it but there are funds available if you truly need it.
I think it all comes down to the highest ‘cost of opportunity’ for your money. It’s a good move to pay the mortgage cash if you are not fully confident that you can put the money to work at a decent rate (i.e. at least twice what the mortgage costs, to account for taxes, trouble etc…). Regardless, paying the mortgage is the safest bet, perhaps not the highest possible yield, but certainly a good way to save on the long run and have less worries.
I agree that the return of capital needs to be a much higher than the mortgage rate to compensate for the trouble and extra risk, but would double the mortgage rate be too hard to reach? Even at these record low mortgage rates, 2x 5% is going to be 10%. While it’s possible to get that much, I’m not sure if anyone can confidently and safely execute 30+ years of that kind of average return.
Why would you even need close to twice the cost? There would be no extra risk if you keep the ability to pay off your mortgage at any time within a short period of time. All of the extra expenses such as taxes, insurance and home repair will be there regardless. In fact, your mortgage interest is simple interest and your returns would be compounded so you might not even need to beat your mortgage rate.
One mistake I see people making is that they think investing. Why would you risk this money? You need this money don’t invest it to risk it.
I totally agree with you. I’d much rather be debt free as well and just pay off the house so I can invest in other things. That’s really great that they even have an option to pay off the house.
This is a no brainer…… Pay Cash 🙂
Peace of mind – security – always a roof over your head… job or no job.
Don’t worry about furniture…. you can furnish a house for under $3000 if you shop wel, and use what you already havel… and then save up cash to upgrade the furniture as you can. Do NOT go in debt for furniture.
And get the paperwork done for a HELOC as soon as possible for an emergency fund…. that will open up the equity in your home, in case you need it for an emergency…. but DON’T dip into it unless it is an absolute emergency.
Good advice marci.
I think furniture can wait too, and it might be fun to make it a point to furnish the rooms once a month. If nothing else, it will prolong the “new leather smell” of your home purchase 🙂
I think the benefits of being debt free outweigh the potential gains by investing the excess.
If you had made the decision to invest a couple of years ago you would have probably lost a good part of your reserves.
You just have more freedoms when you aren’t saddled by debt. Life throws curve balls.
cd :O)
In my country (Sweden) nobody mortgages. Banks discourage it. I mortgage less than 100 USD a month. My mortgage is 3.5%. Interest on high savings bank account= 3.25. No brainer.
But nevermind, if you are so unfortunate to live a country where the banks and corporations rob you, you have to join and into them. Dividends alone on half way respectable investments should cover your mortgage rate, even if the stocks went to hell.
But you need some capital and some investment savvy to make it work. Most average income people don’t have this. Therefore pay cash and continue to be doomed as a slave of the system.
If a person had credit card debt, everyone would say pay it off if possible. If a person had a car note, everyone would say pay it off if possible. Debt is debt, why have it if you can avoid it. Is it possible for the benefits of a mortgage to outweigh the costs of the mortgage?
Assuming there is an income stream, without mortgage debt the savings will be recovered quickly.
Good point. Perhaps the size of balance and length of payment period has something to do with the advice?
I’ve been told that there are some cases where the tax benefits are worth keeping a balance.
Paying off credit card debt is not the same as a mortgage. First, what you bought with the credit card is probably losing value whereas a home will increase in value as time goes by. Second, the tax deduction you are allowed on interest paid on a mortgage is not allowed on credit card puchases. There are two things and two things only you should finance: Real Estate, and an education. Everything else, if you can’t pay cash, you can’t afford it.
I agree with Hugh, while there’s still a tax deduction for mortgage interest, and with the interest rates so low put 20 – 30% down.
This is a false premise and if you have financial advisers saying you should do this, I suggest you fire them.
Yes, you do get a tax deduction. But it is not a tax credit. Lets say you pay 5,000 a year in loan interest and you are in a 15% tax bracket. With the mortgage deduction, you can reduce your taxable income by 5,000. How much does this save you in taxes? 5,000 x .15 = 750 So you are going to save $750 off your tax bill.
If you had payed in full, you would own the government $750 more then if you would have paid in full. Doesn’t sound good does it. But, your spent $5,000 in paid interest to the bank to save that $750. So, you are $4,250 worse off then if you would have paid in full and not carried a mortgage.
It is better to pay the government $750 then pay the bank $5,000. How many of your financial advisers work for banks??
You’re ignoring the other half of the situation. The person who opts for a mortgage rather than paying cash for the house has a mountain of cash that will not sit under a mattress. It will be invested, and the proceeds of that investment will pay for the mortgage. If the person were to put the cash under a mattress, as your example suggests, your analysis would be spot on.
The real analysis here (ignoring any emotional considerations) depends on the interest rate on the mortgage, the marginal tax rate, the return on the investments funded by the cash, and the liquidity of these investments.
This is the most reasonable argument that I’ve seen. James, you are spot-on. Everyone who argues for a mortgage because it frees up your money to be invested is ignoring the fact that without a mortgage you will still have money to be invested! Whatever money you would pay toward a mortgage can be invested instead, and the return it yields won’t be offset by the rate paid on your mortgage – it will be pure gain.
It’s simple math. If you invest money equal the value of your home at 8% but you’re paying 3% on your mortgage, you’re really only earning 5%. If you invest at 8% without a mortgage, you’re earning 8% period. Granted, it’s 8% on a smaller amount, but it is still a higher yield and you have 100% equity in your home when you decide to sell.
So it’s not like the money you spent disappears, you get it all back when you sell (plus a little bonus if your home value increases).
Which makes more financial sense?
Just bought a short sale and paid cash. Still had $ for closing and repairs and built up what was left. I have $700 just for emergencies and another for the house fund. Having a mortgage would have only benefitted the lawyer for closing fees & the bank and wouldn’t Uncle Sam tax that $$ over 10K left in the bank? So, Uncle Sam would have benefitted as well. I came in with equity and didn’t have to deal with the mortgage process thankfully. Remember you only get a tax credit if you file and have met other criteria like enough exemptions.
I’d love to pay for it in full, but it’s just not possible. Pay in full.
It’s all in the actual numbers. What kind of deal can you really get by paying in cash, how much interest rate and the fees are going to be, and how aggressive you are with your investments.
Discipline is one thing, but negotiation and planning, at least as it seems, is a big part of this whole equation too.
When else in your life will someone give you hundreds of thousands of dollars at a low interest rate that is probably tax favorable? This might be your only chance. If you are responsible enough to save up that much cash then my guess is you are responsible enough to properly manage the equity in your home. Now there may be a mental battle here because emotionally it might be better to pay cash but rationally it might be better to be mortgaged to the hilt. So shoot for somewhere in between, 80%?