…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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{ 23 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 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.