The decision of whether to buy a house with cash or take out a mortgage may be one that most people never have to face. For the most part, American society is comfortable with the idea of going in debt to buy a house for two reasons. First, the value of a house is expected to rise over time, and second, if debt was not available for buying a house, many families would never be in a financial position to own.
If you are blessed with cash available to purchase a home without the help of a lending institution, should you do it? There are certainly many advantages of buying a house with cash, but some disadvantages as well.
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Cash advantage #1: no hassle. The process of qualifying for a mortgage is a hassle, even if you show you have significant assets and income available. You need to have established credit for a lender to be able to evaluate its risk in you, but with cash, you are no risk. You save time with paperwork and, in theory, the purchase process will be faster. For a seller, a buyer who presents cash may have an advantage over those who are tied to a mortgage lender’s involvement.
Cash advantage #2: less expensive. You might be able to negotiate a better purchase price when you have cash to show, but there are many other areas you can save money. Closing costs might be less, and without a mortgage you don’t have to worry about paying points. Over time, the bulk of the savings comes from interest. On a $250,000 mortgage at 7% over 30 years, you could pay almost $350,000 in interest. Pay $250,000 up front and save your money.
Cash advantage #3: no payments in retirement. With thirty-year mortgages being the norm, families who wait before buying a house may find they’re still have a balance to pay their lender by the time they retire. During retirement, income could be significantly reduced, making those mortgage payments more difficult to pay. Those with a mortgage should do what they can to eliminate payments before retirement, but if you pay cash, you never have to worry about changes in your future income affecting your ability to hold onto your home.
Cash advantage #4: you’re not a slave. I don’t fully subscribe to the idea that debt is slavery, but when you owe money to someone else, you certainly lose some of your freedom. For example, a Philadelphia homeowner was notified by his lender, Wells Fargo, who may no longer even own the mortgage due to securitization, to increase his insurance policy to covered the full replacement value of his home rather than the house’s market value. The charges would have added $500 to his monthly bill. Although the owner might be able to fix the situation, without a mortgage, Wells Fargo wouldn’t have been harassing him.
Mortgage advantage #1: bigger financial reward. It comes with risk, but if you’re planning to stay in house for several decades, and you do stay, your financial gains could be greater if you finance the purchase. If after ten years the value of the house increases by $200,000, all that increase belongs to you even if you don’t own the home outright. You could even cash out that increase if you need the money for some reason. The other size of this is that if the value of the house decreases, you are on the hook for that loss, and in many circumstances, you could end up underwater, owing the lender more than your house is worth.
Mortgage advantage #2: afford a bigger or better house. Even if you have the ability to buy a house with cash, you may still want to choose a mortgage. If you expect to have more cash on the way, you can use your current assets to help you afford a much bigger home, if that is something that is important to you. With $400,000 cash available today, for example, you could either buy a home without a mortgage or use a portion or all of that cash for a down payment and closing costs. As long as you expect more income in the future to pay for the mortgage payments, you can use today’s cash to your advantage.
Mortgage advantage #3: get tax breaks. Yes, it’s true that at least as of today, there is a tax deduction for mortgage interest. This isn’t as great a benefit as most people believe, however. You get back only a portion of each dollar in interest you pay, and the benefit is limited by income. Even with a middle-class salary, you might be prevented from taking this deduction. Of course, if you pay cash for a house, you pay zero interest, which is much better than paying interest and getting a portion of it back from the government.
Mortgage advantage #4: diversification of assets. Just having the cash to spend isn’t the only consideration. If the house you want costs $450,000 and you have $460,000 in cash ready to go, you will be left with only $10,000 for all of your other savings needs, including an emergency fund. Using all of your cash to buy the biggest house your money can by is putting all your eggs in one basket. If you have enough cash so the home purchase only requires a portion of your assets, you may still consider your financial condition safe, but once you shift all your liquid savings into an illiquid asset like a house, you may have trouble getting cash when you need it.
Would you jump at the chance to pay for your dream home with cash, or would you consider taking out a mortgage even if you have cash available?
Updated October 21, 2015 and originally published February 25, 2011.