Paying Cash for a Home vs Taking Out a Mortgage

[QofQuimica]

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Has anyone ever come across a good cost analysis of home-buying options (or done one yourself) that you could post a link to? I'm guessing the reason few people buy their homes outright is because most don't have that kind of cash on hand. But I'm curious how the overall numbers would work out for buying with cash and avoiding interest payments vs taking a mortgage and getting the tax deduction for it.

 

[mgdsh]

The mortgage interest deduction is one of the best deductions you can have.

Chances are you can find and do other things with your money to yield more than 4% a year. That equivalent percentage is even less once you factor in the interest deduction.

 

[Cooperd0g]

There is also the cost associated with rent. I don't agree that renting is just "throwing money away" because many times it is a smarter financial move. However, if you intend to stay in one place and eventually buy then a good portion of rent money could be going towards the mortgage payment. White Coat Investor had a recent blog about paying off his mortgage early. In there he talks about because he has a low rate (2.75% on a 15 year loan) and a high tax bracket (38% combined federal/state) his effective mortgage rate after tax is only 1.7% which is about equal to, or lower than, inflation. So if you had a big down payment and a low rate then having a mortgage isn't necessarily bad when you could get into your house earlier than if you stayed as a renter and saved the cash.

http://whitecoatinvestor.com/a-scheme-to-pay-off-my-mortgage-early/

 

[James Martin]

If you have money sitting in the bank, it definitely makes sense to buy with cash. If you have some money, but not a huge amount, I think it still makes sense in this economic climate, as you will likely buy a smaller property and be more careful about what you are buying then you have an outright loan. Getting mortgages is easy and it has resulted in people buying homes beyond their means.

 

[sazerac]

The mortgage interest deduction is difficult to analyze, because there are so many variables.

The standard deduction runs in the thousands of dollars. If your deductions aren't much more than that, you really aren't saving much. Deductions are also limited when your income gets high. The alternative minimum tax might kick in, severely limiting your deductions.

When I tried to analyze this myself, it was so messy that I finally gave up and just paid off the mortgage. Emotionally, it was very satisfying to have no more debt or monthly payments anymore, even if it did cost me some bucks in the long run. I slept very well at night.

 

[QofQuimica]

The mortgage interest deduction is difficult to analyze, because there are so many variables.

The standard deduction runs in the thousands of dollars. If your deductions aren't much more than that, you really aren't saving much. Deductions are also limited when your income gets high. The alternative minimum tax might kick in, severely limiting your deductions.

When I tried to analyze this myself, it was so messy that I finally gave up and just paid off the mortgage. Emotionally, it was very satisfying to have no more debt or monthly payments anymore, even if it did cost me some bucks in the long run. I slept very well at night.

Yes, this is my issue as well. Up to this point, I have always taken the standard deduction and have certainly not earned anything close to what would be necessary to pay AMT. That is likely going to change this year. Other complicating factors are that I don't know how long I will stay in this location (making me less likely to want to buy a home at all), and like you, I dislike carrying debt. There is just something very psychologically satisfying about simply paying for what you want and being done with it.

If you have money sitting in the bank, it definitely makes sense to buy with cash. If you have some money, but not a huge amount, I think it still makes sense in this economic climate, as you will likely buy a smaller property and be more careful about what you are buying then you have an outright loan. Getting mortgages is easy and it has resulted in people buying homes beyond their means.

That's not the issue in my case, as I would buy a home I could afford to pay off even if I chose to take a mortgage for the deduction. But good point in general not to buy beyond one's means.

There is also the cost associated with rent. I don't agree that renting is just "throwing money away" because many times it is a smarter financial move. However, if you intend to stay in one place and eventually buy then a good portion of rent money could be going towards the mortgage payment.

And that is the big question: do I want to stay here for the long term. Jury's still out on that one.

The mortgage interest deduction is one of the best deductions you can have.

Chances are you can find and do other things with your money to yield more than 4% a year. That equivalent percentage is even less once you factor in the interest deduction.

I wouldn't consider any money I used to buy a home to be part of my investments. In general, I don't believe that homes make particularly good investments. In fact, they're more of liabilities in the sense that they cost you money (upkeep, taxes, etc). But you have to pay to live somewhere regardless (rent or buy), and if the market cooperates, many people have a decent chance of ending up with an inflation-adjusted "gain" when they go to sell their homes.

 

[KM Awad]

It really depends on the mortgage interest rate and whether you earn more by investing. But people only look at the positives and assume that they will earn 8% per year no matter what, which is completely unrealistic.

I don't think anyone can fault you for paying off your mortgage. And guess what, if you miss your mortgage, you can always get another one. I'm going to guess that this won't happen ...

 

[mgdsh]

Sometimes it can make sense to pay cash for a home in that you can get a much better price, especially with a desperate seller. You can then refi (yes I know rates are slightly higher), but you'd have a smaller mortgage amount (sometimes up to 20% smaller).

 

[Plastikos]

If you dont know if you'll be staying for absolutely sure, it makes zero sense to buy, just dont. Renting premium is paid for in its liquidity utility, you can just up and leave no strings attached.

It makes no mathematical sense to buy straight cash unless for buying options which are then refinanced like the above post mentions. Homes are a consumptive item and should not be viewed as investments, the one you plan to live in of course. They are most likely outside of bubbles and other regional pecularities to simply increase with the rate of inflation and thus provide no gain in purchasing power. The rates are so low now that they are an excellent hedge against inflation. I'd put enough down to make my payment small (here you'll not get much interest deduction due to rates/principal size) and invest the other money somewhat aggressively. There are zero other investments that long term compete with the future purchasing power of the market. If you dont feel like learning much yourself you can go the simple route by indexing.

Trust the math, not your guts.

 

[Chip N Sawbones]

Paying cash can give you a serious advantage when buying a foreclosure, since getting a mortgage to finance a foreclosed house tends to require lots of extra hoops to jump through. If you want the most house you can possibly get for your money, cash+foreclosure is definitely the way to go, as foreclosed houses are usually sold at about a 20% discount anyhow. The disadvantage of this is that you're basically buying the house as-is, so make sure you've identified anything that needs to be fixed and budgeted in the cost of repairs before you buy.

Also, no matter what kind of house you're buying, you should always ask the sellers what their cash price is. This is true even if you know you won't possibly be able to pay cash. Knowing if they're willing to pay less for a fast cash sale will give you a good idea of how desperate they are to sell, and how much room you have to negotiate when you put in an offer.

 

[QofQuimica]

Also, no matter what kind of house you're buying, you should always ask the sellers what their cash price is. This is true even if you know you won't possibly be able to pay cash. Knowing if they're willing to pay less for a fast cash sale will give you a good idea of how desperate they are to sell, and how much room you have to negotiate when you put in an offer.

I like that idea. Thanks.

At this point, I've decided to start saving up money for a down payment while I think about where and when I might want to actually buy something. I figure it will probably be at least a year until I'm even in a financial position where any of this will start to matter. And if I ultimately decide not to buy anything, I could always use my down payment savings to go on a really nice exotic vacation. 😀

 

[bwmd]

How much the deductions help also depends on the local real estate taxes. Depending the house price, current interest rates, and local real estate taxes, you can estimate the tax benefit (though as a poster above other factors can play in depending on how much you earn and how much house you're looking to buy). We save an extra 5k in deductions in the end by itemizing on top of the mortgage, but it's also a hassle if you don't have any other significant reasons to itemize.

 

[Mman]

How much the deductions help also depends on the local real estate taxes. Depending the house price, current interest rates, and local real estate taxes, you can estimate the tax benefit (though as a poster above other factors can play in depending on how much you earn and how much house you're looking to buy). We save an extra 5k in deductions in the end by itemizing on top of the mortgage, but it's also a hassle if you don't have any other significant reasons to itemize.

State and local income taxes are a large deduction for most attendings (in states with state income tax) on their federal return.

As for mortgage interest, how much the deduction helps depends on your exposure to AMT. When I started getting hit with that I got tired of having a mortgage and quickly paid it off.

 

[KM Awad]

I like that idea. Thanks.

At this point, I've decided to start saving up money for a down payment while I think about where and when I might want to actually buy something. I figure it will probably be at least a year until I'm even in a financial position where any of this will start to matter. And if I ultimately decide not to buy anything, I could always use my down payment savings to go on a really nice exotic vacation. 😀

That would be a very nice exotic vacation for the cost of a down payment!

Where I am, coming to the table with cash, almost makes no difference, because it is a very strong sellers market. A fellow attending, more senior than I am, came to the offer with an entire cash offer and even no inspection, yet still had to compete with others.

 

[The White Coat Investor]

You're right. Most of the time people use a mortgage because they have to. Is it mathematically wise to carry low interest (especially after tax) debt for 15-30 years in order to use your cash to do other, better things (pay down student loans, max out retirement accounts, perhaps even spend?) Probably.

 

[QofQuimica]

You're right. Most of the time people use a mortgage because they have to. Is it mathematically wise to carry low interest (especially after tax) debt for 15-30 years in order to use your cash to do other, better things (pay down student loans, max out retirement accounts, perhaps even spend?) Probably.

I have no student loans; I already max out my retirement accounts plus contribute to a taxable account; and I live in a state with no income tax/take the standard deduction. So I'm not super excited about having a mortgage for any of these reasons....

 

[The White Coat Investor]

Unless you want to invest in taxable "on margin" then pay with cash. That's probably what I would do in your shoes.

 

[QofQuimica]

Unless you want to invest in taxable "on margin" then pay with cash. That's probably what I would do in your shoes.

No, I'm thinking not (about the investing on margin, I mean). When you put it that way, it makes sense to pay cash if possible.