…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.
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{ 38 comments… read them below or add one }
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 maybe a mental battle hear 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%? Remember that your return on equity is always zero http://evolutionofwealth.com/2009/11/return-on-equity-is-always-zero/
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.
I’d love to pay for it in full, but it’s just not possible. Pay in full.
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.
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)
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 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.
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.
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.
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.
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.
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.
I vote for buying the house with cash. That would be such a relief not having to worry about a mortgage payment.
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.
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.
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.”
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.
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.
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.
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
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.
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.
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.
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.
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.