Paying cash for a home would seem to be the ideal way to purchase real estate. No mortgage, so no monthly repayments to worry about. So why is that that those who can afford to do so often decide to take the mortgage instead?
By not taking a loan you save on the interest you would have paid – which is usually greater than any interest you would have earned by investing your cash. So why take a mortgage and not just pay cash to buy your property outright? Here are some of the reasons why some choose to take a mortgage and some prefer to pay cash for their home.
Benefits of Paying Cash for a Home
By paying cash you can regard your home as an investment. The return on your investment is not your home – you would have that irrespective of paying cash or paying a mortgage. Your actual return on your cash payment is the interest rate you would have been paying: 5.0% or whatever the rate on the loan might be.
If you can make more than that by investing your cash elsewhere, then it is not economically sensible to pay cash for your home. Sure, you have the knowledge that you own your home outright, but what does that actually mean in financial terms? It means that your equity is 100%, and you also gain as your property appreciates in value.
Sure, your equity is 100%, but if you had to use that as the security for a loan you would be paying a higher interest rate than your mortgage rate. Had you not been paying cash for a home, you would not have required the loan. Once you have taken a loan or second mortgage it is highly likely that the rate will be appreciably higher than that for your regular mortgage (unless you mortgage rate is fixed at a high level.)
Because your cash is tied up in your home, your liquidity may be severely limited. Have you planned for your kids’ education and can you pay your medical expenses and other expenditure that become necessary as you grow older? If you take a secured loan on your home to raise such funds, then you are defeating the purpose by paying a high interest rate.
Most people with enough cash to buy their home outright without worrying about these aspects of their future life have a lot more cash to spare than just that. However, if you have made a decision to use all your savings to buy your home, then you must consider factors such as these.
Will You save Your Mortgage Interest?
It is not a simple matter of saving on all that interest you would be paying: Over $36,000 in the first 5 years alone on a $200,000 30-year mortgage at 3.8% interest! It’s what else may you need to use that cash for other than buying your home.
You might not miss the monthly mortgage payment being taken from your salary every month, but you sure will feel it if you have to pay a whole year’s worth in one lump sum in an emergency.
The point being made is that paying cash for a home might initially seem the best option financially, but you have to consider whether or not you would be actually be realizing your paper savings so that you have it when you need it. Will you have that $36,000 in your savings account at the end of those 5 years?
Effect of Boom and Bust Periods
Stock rates can fluctuate above and below current mortgage rates. During a recession you would be better to own your home outright since it cannot be taken from you. Had you taken a mortgage and invested your cash, you would have been kicking yourself for making the wrong decision. Your house value would be dropping along with your savings and you might even find yourself in a position where the repayments were beginning to become an issue.
When the markets start to recover and real estate values increase, then you also recover and your equity increases again. The only constant is your home ownership. You not only have a roof over your head, but the full value of your home to fall back on if you have to release some of it.
Conclusion: Get Professional Mortgage Advice
So which is best? If you save the interest you would have been paying had you taken a mortgage, then paying cash for a home becomes a more attractive proposition. When you take tax advantages of a mortgage into account, the lower closing costs of paying cash that have not yet been discussed and the possibility of a cash discount, cash might or might not swing it – but get professional mortgage advice before using all your savings. Have questions? We can help!