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My girlfriend got some family money and is planning to buy a house. She has the money to purchase the house outright with cash. But she is thinking of putting 50% down and get a mortgage for the remainder. Ostensibly to get the home owner's interest tax deduction.

I am arguing that it's better to pay the whole thing off, because whatever interest she can deduct on her taxes is unlikely to be more than she would pay as a part of the mortgage.

Am I wrong? Am I overlooking some other benefit?

This is a strictly monetary question. For the moment, I am putting aside the hassle of having a mortgage.

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    You have to pay the interest to be able to deduct the interest..... if you can avoid paying the interest that would be more valuable than the tax break on the interest. – quid Dec 10 '16 at 1:09
  • Note: With the new tax laws passed around late 2017/early 2018, for many people, especially married couples with smaller mortgages, the tax deduction will be worth little or nothing. With state and local tax deductions capped at $10K, and a standard deduction of $24K for married couples, and few remaining itemized deductions, you'd have to pay $14K in combined mortgage interest and charitable contributions before deducting would save you anything (and it would only save you money on the amount above $14K). If you're putting 50% down, the odds of the interest reaching that level is low. – ShadowRanger Jul 22 at 20:01
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Not for the tax break, no; as others have said that still costs you money.

However, with rates being low right now and brought a bit lower by the tax break, this is an opportunity for the safest form of leveraged investing you will ever find. If you invest that money, the returns on investment will probably be better than the mortgage rate, and that leaves you with a net profit. There is some risk if the market collapses, but it's less risk than any other form of borrowing to invest.

That also leave you with more flexibility if you need cash in a hurry; you can draw down the investments rather than taking another loan.

If the risk bothers you, you can do what I did and split the difference. I put 50% down and financed the rest. I sometimes regret not having pushed it harder, since it has worked out well for me ... but that was the level of risk I was comfortable with.

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"Getting a mortgage for the interest write-off is like buying packs of baseball cards for the gum."

That said, I'd refer you to The correct order of investing as much of that question really overlaps with this.

This question boils down to priorities, the best use of the funds. There are those who suggest that a mortgage brings risk. Of course it does, just not for the borrower, the risk is borne by the lender. Risk comes from lack of liquidity. Say your girlfriend buys the house with cash, and leaves little reserve. She loses her job, and it's great that she has no mortgage. But she does have every other cost life brings, including a tax bill that can turn into a house getting foreclosed on.

The details that you didn't disclose are those needed to look at the rest of the "priorities" list. A fully funded 401(k) with appropriate balance, and no other debt? And a 1 year emergency fund? I wouldn't argue against buying the house with cash. No real savings and passing on the 401(k) matched deposit? I'd think carefully about the longterm impact of the cash purchase.

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Except for unusual tax situations your effective interest rate after taking into account the tax deduction will still be positive. It is simply reduced by your marginal rate. Therefore you will end up paying more if the house is financed than if it is bought straight out.

Note this does not take into account other factors such as maintaining liquidity or the potential for earning a greater rate of return by investing the money that would otherwise be used to pay for the house

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Your wealth will go up if your effective rate after taxes is less than the inflation rate. That is, if your interest rate is R and marginal tax rate is T, then you need R*(1-T) to be less than inflation to make a loan worth it. Lately inflation has been bouncing around between 1% and 1.8%. Let's assume a 25% tax rate. Is your interest rate lower than between 1.3% and 2.4%? If not, don't take out a loan.

Another thing to consider: when you take out a loan you have to do a ton of extra stuff to make the lender happy (inspections, appraisals, origination charges, etc.). These really add up and are part of the closing costs as well as the time/trouble of buying a house. I recently bought my house using 100% cash. It was 2 weeks between when I agreed to a price to when the deal was sealed and my realtor said I probably saved about $10,000 in closing costs. I think she was exaggerating, but it was a lot of time and money I saved. My final closing costs were only a few hundred, not thousands, of dollars.

TL;DR: Loans are for suckers. Avoid if possible.

  • Also, proving to the lender each year that you've paid the property tax, you have fire insurance... – DJohnM Dec 10 '16 at 6:31
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    I'll grant appraisal (as the buyer knows what they think the property is worth) as unnecessary but Inspections and title insurance protect the buyer just as much as the lender from seller legerdemain – user662852 Dec 10 '16 at 13:40
  • Title insurance is paid for by the seller. Inspections are optional--you can get one if you want it. I don't remember all the things we saved on but as we went through the closing there was item after item that came up (including stupid stuff like courier fees, credit checks, etc.) that I would have had to pay for and didn't. It was absolutely thousands of dollars. When you buy a house, a shocking number of people have their hand in your pocket. Much less so if you buy with cash. – farnsy Dec 10 '16 at 15:08
  • @DJohnM I'm not sure what you are saying. With a loan, you pay extra for your homeowner's insurance. If you buy with cash you pay directly to the insurance company and it's not any more expensive. The only benefit I can imagine a lender providing is the option to default and walk away if housing prices drop rapidly in your area and your home is worth less than you owe. – farnsy Dec 10 '16 at 15:11
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    Title insurance is not always paid by seller. Common practice varies from market to market. Know what your transaction entails. – keshlam Dec 10 '16 at 18:28

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