Advantages and Disadvantages of Buying a House With Cash vs Getting a Mortgage...
Almost 90% of recent buyers financed their home purchase, according to the 2018 Profile of Home Buyers and Sellers from the National Association of Realtors (NAR).
A recent index from the NAR showed that 19% of homebuyers in May 2019 paid cash.
If you’re one of the lucky few who can pick which category you fall into, read on as we describe the pros and cons of paying for your home in cash versus getting a mortgage.
It’s certainly not as simple as eliminating a mortgage payment and a variety of factors should be considered, including current mortgage rates, the amount you need to finance, and your own unique financial situation.
Reasons To Consider Paying Cash For a House
One of the primary reasons to pay cash for a house is to own the home outright.
There are fewer fears of foreclosure if you don’t owe a lender (though you could still lose your house if you don’t pay your property taxes, for example), and you also don’t have to worry about defaulting on a home loan which could negatively impact your credit.
Owning the home outright also means you have the right (but not the obligation) to borrow against the 100% in equity you have in your home if needed.
Lower monthly payments
You won’t have to dedicate a significant portion of your income toward a monthly mortgage payment, which means more free cash flow for other needs every month.
Keep in mind that you’ll still be responsible for a number of expenses after purchasing a home including applicable homeowners association fees, homeowners insurance, property taxes, and maintenance costs, even without a mortgage.
Eliminating mortgage payments typically cuts down on the largest monthly expense for most American households.
Save on interest
You can stand to save thousands — or even hundreds of thousands of dollars — in interest expense simply by not having a mortgage, which can represent a huge amount over 15 or 30 years.
What makes home loans expensive is the sheer size of mortgage loans. As a point of reference, taking out a $160,000 mortgage loan at a rate of 4.375% can cost over $120,000 in interest expense when paid off over a 30- year period.
Regardless, it’s important to note that mortgage debt is among the cheapest debts that Americans can take out on an APR basis.
Depending on the portion of your savings you tie up purchasing your home, it’s worth evaluating whether you’d be better off paying for your home in cash or taking out a mortgage and investing your savings in a well-diversified investment portfolio.
Faster closings and lower closing costs
Paying cash for a home also means less spent on closing costs and faster closings.
New York City-based real estate broker Joseph Fan explains that “…buying with cash may mean less headache… you call the shots, and you don’t need to worry about the lender’s rules.”
Buyers paying in cash can avoid a number of fees associated with a loan, such as origination fees, underwriting, mortgage insurance premiums, and credit report fees, which can result in thousands of dollars of added expenses.
Another advantage is how quickly you can close on a home when you’re making a cash offer. “When making an offer, the words ‘all cash’ have a lot of power,”
Fan said. “An all-cash deal that is lower than the asking price might be able to win out against an above-asking traditional mortgage bid, especially if the latter deal is contingent on financing.
Your credit score or citizenship status doesn’t really matter much once you are an all-cash buyer.”
Beat out competing buyers
Sellers prefer all-cash buyers because of how fast a deal can close.
While a buyer who’s applying for a mortgage has to deal with the lender’s timeline, which includes scheduling an appraisal and going through the underwriting process, buying with cash usually only requires due diligence on the buyer’s part, the seller and buyer can then pick a mutually agreeable closing date without the need to deal with a third-party lender’s timeline.
In a competitive market where sellers have plenty of interested buyers, the speed and ease of a cash offer make you more attractive than traditional homebuyers.
Rather than waiting for the buyer to be approved for the loan, which isn’t always guaranteed — even with a preapproval — sellers know they can have cash in hand without too much hassle if they take your offer.
Reasons To Consider Getting a Mortgage
Even if you have the cash to fund a home purchase, it’s not always the best option. Among the benefits of getting a mortgage include the corresponding opportunity costs, the ability to grow wealth using leverage, and ancillary credit and tax benefits.
You may earn more elsewhere
If current mortgage rates are lower than the average rate of return on the stock market, it may make more sense to invest your money rather than lock it up in a large purchase.
Taking out a mortgage to buy a home is often compared to carrying a negative interest rate on your home loan.
Conversely, by buying a home using 100% cash, you essentially lock in a rate of return equivalent to whatever current mortgage rate you could have taken out.
As a point of reference, the average return of the S&P 500 over the past 80 years was just over 9% per year.
Compare this to the current average rate on a 30-year mortgage of approximately 4.2% as of the time of this writing, and it quickly becomes evident the potential investment earnings you might have foregone, assuming you took out a mortgage and invested the cash you would have spent on the house in a well-diversified portfolio of stocks and bonds.
Leverage your debt
Paying cash for a house enables you to use that money for your home purchase and nothing more.
Once you lock in the purchase of the home, that money is inaccessible unless you decide to refinance the property or take out a home equity loan.
The growth potential is therefore directly linked to your property’s ability to appreciate. If you live in a flat or declining real estate market, this could actually lead to a negative return on your home purchase.
However, if you were to take out a mortgage for all or a portion of your home purchase, that leaves you with significant cash savings you could invest elsewhere for a return while taking advantage of the relatively low-interest rates on mortgage loans.
Improve your credit score
While not the quickest option for building credit, having a mortgage and making timely payments will also help your credit score over the long haul.
The credit reporting agencies generally prefer a greater diversity of debt, and home loans are generally treated as a productive form of debt that improves a borrower’s credit profile.
While it may only be a few points in the short run, after several years, not having a mortgage could mean a lost opportunity to significantly boost your credit.
Take advantage of the tax deduction
Finally, mortgage debt has the advantage of being tax-deductible.
Home-buying married couples can generally write off mortgage interest on their taxes up to a maximum of $750,000, or $375,000 if married filing separately.
Although this write-off isn’t as lucrative as it has been in previous years after tax reform in 2018, it still represents a benefit for a portion of homeowners with outstanding mortgages.
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