Mortgage vs. Cash for U.S. home buy now

Question

I was sure this question must have been asked and answered here long ago, but I've looked and can't find quite this question, in its most direct/blunt form, which is:

If you can do it, when is it better to buy a house in cash vs. getting a mortgage?

(This is asked for the U.S., in the post "2008+" recession era.)

Or, less extremely, is it best to get as small a mortgage as you can, and put as much cash into the buy as you can, or is it better to limit one's cash payment and take on a bigger mortgage?

Now, obviously, if you somehow have a guaranteed interest that is huge, such as the 17% CD rates of the 1980s, and you have a 5% mortgage, the math works out that (all else being equal) you should take as big a mortgage as you can. But that is certainly not the case today, with CDs at abysmal payouts.

FWIW, I have been of the "save hard and someday buy a house cash" school of thought; I liked the idea of side-stepping the banks, paperwork, not worrying about my credit rating for it/approval, of not taking on a debt, knowing the buy was already a done deal, and, importantly and as regards personal finance, not paying possibly $100k+ in interest over 30 years.

But I know that's not the entirety of the considerations, and some might be subtle or quite unknown to me. And so I'd like to be clearer on whether my strategy is the best one, given my (understandable) goals to save money and live securely and well. I think this is a crucial question in one's financial life, and so I'm hoping we can get some comprehensive, up to date, sourced, and quantified answer(s) here. Thanks.

Answer 1

I'm in the "big mortgage" camp.

1. Money in your house is hard to access if you run into financial difficulties. If you lose your job, you can't refinance or get a home equity loan because you can't prove that you can pay for it.
2. Interest rates are currently low, but they may rise in the future. Historically, it has been possible to get a higher interest rate on savings accounts than current mortgage rates.
3. Investment is a good habit to get into, and may - in the long term - return a better interest rate than your mortgage rate on the long term.
4. Housing has been a great investment in some times, and a horrible investment at other times. Either way, however, the only way to realize the gain is to sell your house.

Or, to put this another way - what would you be happier to have in 15 years? A house that is worth $300,000, or $50,000 of equity in a house and $225,000 in the bank? I would much rather have the latter; it gives me so many more options.

(the numbers are rough; you can figure it out yourself based on the current interest rate you can get on investments vs the cost of mortgage interest (which may be less if you can deduct the mortgage interest)).

Answer 2

If you are investing in a mortgage strictly to avoid taxes, the answer is "pay cash now." A mortgage buys you flexibility, but at the cost of long term security, and in most cases, an overall decrease in wealth too.

At a very basic level, I have to ask anyone why they would pay a bank a dollar in order to avoid paying the government 28 - 36 cents depending on your tax rate. After all, one can only deduct interest- not principal. Interest is like rent, it accrues strictly to the lender, not equity. In theory the recipient should be irrelevant. If you have a need to stiff the government, go ahead. Just realize you making a banker three times as happy.

Additionally the peace of mind that comes from having a house that no banker can take away from you is, at least for me, compelling. If I have a $300,000 house with no mortgage, no payments, etc. I feel quite safe. Even if my money is tied up in equity, if a serious situation came along (say a huge doctors bill) I always have the option of a reverse mortgage later on. So, to directly counter other claims, yes, I'd rather have $300k in equity then $50k in equity and $225k in liquid assets. (Did you notice that the total net worth is $25k less? And that's even before one considers the cash flow implication of a continuing mortgage. I have no mortgage, and I'm 41. I have a lot of net worth, but the thing that I really like is that I have a roof over my head that no on e can take away from me, and sufficient savings to weather most crises).

That said, a mortgage is not about total cost. It is about cash flow. To the extent that a mortgage makes your cash flow situation better, it provides a benefit- just not one that is quantifiable in dollars and cents. Rather, it is a risk/reward situation. By taking a mortgage even when you have the cash, you pay a premium (the interest rate) in order to have your funds available when you need it.

A very simple strategy to calculate and/or minimize this risk would be to invest the funds in another investment. If your rate of return exceeds the interest rate minus any tax preference (e.g. 4% minus say a 25% deduction = 3%), your money is better off there, obviously. And, indeed, when interest rates are only 4%, it may may be possible to find that. That said, in most instances, a CD or an inflation protected bond or so won't give you that rate of return. There, you'd need to look at stocks- slightly more risky. When interest rates are back to normal- say 5 or 6%, it gets even harder.

If you could, however, find a better return than the effective interest rate, it makes the most sense to do that investment, hold it as a hedge to pay off the mortgage (see, you get your security back if you decide not to work!), and pocket the difference. If you can't do that, your only real reason to hold the cash should be the cash flow situation.

Answer 3

There are a number of reasons I'm in agreement with "A house that is worth $300,000, or $50,000 of equity in a house and $225,000 in the bank."

• The day after you buy the house with cash, you may lose your job. The bills still come due, including the real estate tax bill.
• It's tough enough to save for a down payment of 20%. Trying to save 100% of the home cost would probably sacrifice retirement savings.
• Worse, there's the risk of ignoring matched 401(k) deposits for the sake of the house savings. I am 51, and am about 20 years into my 30 year's of paying a mortgage, about half the principal is paid off. But, the money sent to my 401(k) has been matched and has grown faster than my mortgage interest rate despite two crashes during this period.

So, the update to the first comment should be "A paid off house worth $300K, or a house with $150K equity and $275K in the retirement account."

Edit - On reflection, an interesting question, but I wonder how many actually have this choice. When a family budgets for housing, and uses a 25% target, this number isn't much different for rent vs for the mortgage cost. So how, exactly do the numbers work out for a couple trying to save the next 80% of the home cost? A normal qualifying ration allows a house that costs about 3X one's income. A pay-in-full couple might agree to be conservative and drop to 2X. Are they on an austerity plan, saving 20% of their income in addition to paying the rent? Since the money must be invested conservatively, is it keeping up with house prices? After 10 years, inflation would be pushing the house cost up 30% or so, so is this a 12-15 year plan?

I'm happy to ignore the tax considerations. But I question the math of the whole process. It would seem there's a point where the mortgage (plus expenses) add up to less than the rent. And I'd suggest that's the point to buy the house.

Answer 4

Buying now with a mortgage gets you:

• Possible monthly cash flow savings compared to renting
• Tax write off on mortgage interest
• Financial leverage in a way that is not available to most people. (25% down payment controls 100% of the asset).
• Lock in a potentially low interest rate with the possibility of refinancing if interest conditions improve.

Waiting to buy with all cash gets you:

• Potentially higher return on cash by investing in other securities
• Higher liquidity

These are also some of the pros or cons for the rent or buy dilemma that Paul mentioned in comments to the OP.

This is a very complex, multi-faceted question, that would not respond well to being put into any equation or financial model. Most people answer the question with "buy the home now with a mortgage" if they can pay for the down payment. This is why the mortgage industry exists.

The people who would want to finance now rather than buy with all cash later would not only be analyzing the question in terms of financial health but also in terms of general well being. They might consider the tremendous pride that comes with home ownership and living under a roof of one's own. Who can say that those people are wrong?

Answer 5

I wondered about this problem too, so I looked into the maths and made this app :-

http://demonstrations.wolfram.com/BuyOrRentInvestmentReturnCalculator/

(It uses the free Wolfram computable-document format (CDF) Player.)

If you try it out you can see what conditions favour renting vs buying. My own conclusion was to aim to buy a property outright upon reaching retirement age, if not sooner.

Example

This example compares buying a £400,000 house with renting for £1,000 a month while depositing equivalent amounts (in savings) to total the same monthly outgoings as the buyer. Mortgage rate, deposit rate, property appreciation and rent inflation can be variously specified. The example mortgage term is 20 years. As you can see the buyer and renter come out about even after the mortgage term, but the buyer comes off better after that, (having no more mortgage to pay). Of course, the rent to live in a £400,000 house would probably be more than £1,000 but this case shows an equivalence point.