Buying a house. I have the cash for the whole thing. Should I still get a mortgage to get the homeowner tax break?

Question

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.

Answer 1

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.

Answer 2

"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.

Answer 3

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

Answer 4

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.