Buy A House With Cash
July 11, 2012 6:12 AM   Subscribe

My wife and I are buying a house in Austin, Texas ( Steiner Ranch ). We are trying to figure out how we want to finance it. We have the means to pay for the house with cash. We are being offered a mortgage at 3.6%. The cost of the house would represent about 50% of our net worth. The other 50% is fairly liquid, with an even spread between 401k, index funds, 529's, and cash. Should we do it?

We are both in our late 30's with two kids ( 2 and 4 ). I am a project manager, my wife is an accountant. The only debt we are carrying is our SUV that is 0% financed. Over the next 5 years the only major expenses we see are home improvements, e.g. landscaping, pool, etc. In the long term, the major expenses we see are college, vacations, retirement and health care.

I suppose this question is about alternative investments and whether or not we could beat 3.6% without taking on too much risk. It is also about the Austin real estate market and whether or not we would kill our leverage if we paid cash. Furthermore it has to do with any tax write offs we may be missing out on. Most importantly it is about your personal viewpoint on home ownership, finance, banking, risk, European default, market trends, etc. With the facts at hand, what would you do?

Answering this question by telling me "It all depends on what you want to do" is not a good answer. I want to put my kids through college, take a few good trips, and retire at a reasonable age. We live frugally, don't buy fancy cars, and could care less about using our money for status. You won't find me taking wild financial bets in the stock market or any other market for that matter. We just want to make a sound financial decision. What's your take?
posted by jasondigitized to Work & Money (24 answers total) 3 users marked this as a favorite
Getting a mortgage is a basically a government entitlement in the form of a tax break. Unless you are a die hard Republican and do not believe that there should be any government subsidies, it is a no brainer to take the mortgage, imo.
posted by snaparapans at 6:22 AM on July 11, 2012 [3 favorites]

Personally I would pay in cash but a couple of things to keep in mind...
- You will need cash in the next few years for repairs, furniture etc. ...that boiler will break, i know its new, but it will break!
- As for tax breaks keep in mind that the money you get back back for mortgage interest is just a portion of the amount you actually paid for interest. People always seem to think they are missing out on free money but that is not the case.
- If you pay in cash you can make up a 'mortgage' payment and put that aside to save each month. Although judging by the fact that you are in this position it seems like you have your financial head on straight.
- Sure you can invest elsewhere and make more money maybe. But even at 3.6% there is no where else you can get that return guaranteed.
In conclusion I would pay cash but only if you have some cash at the ready for emergencies and necessary purchases.
posted by Busmick at 6:22 AM on July 11, 2012 [2 favorites]

I would take whatever option allowed me to be mortgage free. It gives you a freedom very few get to experience. The extra cash flow you realize can allow you choices most don't enjoy. Make the house your own with improvements, invest, develop really robust college funds...go for it!
posted by txmon at 6:25 AM on July 11, 2012

I suppose this question is about alternative investments and whether or not we could beat 3.6% without taking on too much risk.

More realistically it's about whether you can beat 3.6 percent times (1-your marginal tax rate).
posted by ROU_Xenophobe at 6:32 AM on July 11, 2012

How much cash will you have left if you pay cash? I don't like the idea of cashing out your 401k etc., but more than that, I don't like the idea of getting rid of your safety cushion. I can't tell what you're thinking as far as the mortgage goes, but it's worth considering a middle ground where you make a sizable down payment and cover the rest with a mortgage.

I don't think debt is inherently a bad thing -- if it's an amount you can afford and the interest rate is low -- and I get the sense that you seem to think it is. If you really hate debt, fine, don't take on debt because peace of mind has value too, but I don't get why you would pay all the money now when you don't have to (and as far as I can tell, can't easily afford to).
posted by J. Wilson at 6:33 AM on July 11, 2012 [1 favorite]

An an alternative, you could run the numbers on putting 50% down and financing the balance over 15 years. That will get you an even lower interest rate, and depending on the cost of the house, a mortgage payment that is less than your SUV payment! . If you financial situation stays stable I assume you would be in a position to pay it off whenever you wanted to.

But probably, you should find a fee based financial planner, buy a couple hours of his time, and run the numbers in a variety of scenarios to see. There is certainly a lot of financial security in being debt free, but it sounds like you are also in the position to think long term about what you might earn with 30 years of compounding investments if you don't pay cash for the mortgage.
posted by COD at 6:35 AM on July 11, 2012 [5 favorites]

I think this is a personal preference at this point. I chose to pay off my mortgage 4 years ago. While it initially stung seeing my account balance depleted so heavily, from the date the next payment would have been due, I have never regretted it. This assumes you have a cushion, which with 2 incomes and no mortgage payment, is easier to have.

It is really nice to have no mortgage, but remember that property taxes and insurance are really high in Texas (I am in Austin too) so you are still going to have to cough up a chunk of money every year, which stinks.
posted by murrey at 6:40 AM on July 11, 2012

I think COD's idea is a good one. You split the difference and see what happens.

Also, you can always pay off a mortgage early.
posted by gjc at 6:51 AM on July 11, 2012 [1 favorite]

ROU_Xenophobe gets to the heart of the question. Paying off your mortgage means you are not paying interest, but you are not earning potential returns. The stock market has significantly higher expected yields, but of course higher risk.

Two other related issues to consider:

1) Having a mortgage gives you flexibility. This can be a good thing. If you take out a $50,000 mortgage, that means you have $50,000 more in liquid assets if an emergency comes up. If you had paid off the mortgage, it would be locked away and harder to access.

2) Paying cash constrains you. This can be a good thing. If you had taken out a $50,000 mortgage, you might be tempted to spend it. Paying off the mortgage is a way of locking the money away, making it harder to access. (It sounds like that would be less of an issue for you than for most people.)

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posted by Mr.Know-it-some at 7:03 AM on July 11, 2012

Not sure if you've looked into it, but you can also get things like a 5-year fixed rate mortgage from ING Direct for about 2.7%. Easier to beat 2.7% in returns than 3.6%! Just something to think about.
posted by jabes at 7:03 AM on July 11, 2012

I'd take the mortgage as a 30 year fixed. 3.6% is a crazy cheap loan. After the mortgage tax deduction the real rate to you is more like 2.4% (assuming 35% tax bracket). Historically diversified investment returns in the US have been roughly 6% (for instance, Vanguard's stock/bond mix fund). Of course returns aren't guaranteed, and in the past few years getting any sort of positive return has been difficult. But on a 30 year horizon I still expect my investments to do better than 3%.

The other advantage of the mortgage is flexibility. Put the money you would have spent on the house in a nice, long term investment. Don't spend it on something else. But if something changes and you need liquid assets, it's sitting there for you to access. For me that's peace of mind. The negative side is you might be tempted to spend that money on something frivolous instead. Don't do that.

BTW your 50% of liquid assets includes 401k and 529 plans. While those are technically liquid in an emergency, there are significant tax penalties for spending them on anything other than their earmarked purposes of retirement and education. I don't look at that kind of money as truly liquid, myself. That argues even more for taking the mortgage, since you have less liquidity.
posted by Nelson at 7:08 AM on July 11, 2012 [1 favorite]

It is all about leverage. If you can put just 20% down at the interest rate you mention you will have a whopping 80% of the cost of the house to invest at a hopefully higher rate. So let's do the maths... 20% down, and a tax deduction that in many cases = 20% of your mortgage, at least during the early years, a house that is earning equity on 100% of the value, but only a 20% investment, and a whole lot of money left over to invest elsewhere.
posted by Gungho at 7:09 AM on July 11, 2012

Response by poster: The issue I have right now is that most of my CFA / Hedge Fund friends are telling me that there is huge volatility and uncertainty in the market right now. If Italy decides to default, I am thinking a 3.6% return looks pretty good right now. I am a Vanguard customer myself and I am not sure I could bank of a 6% return for any index fund over the next 10 years.
posted by jasondigitized at 7:23 AM on July 11, 2012

I also vote for taking the mortgage.

Again, your real "return" on buying the house is less than 3.6%, since the interest is tax-deductible. Even if you have concerns around poor returns in the markets more generally, there are other very low risk investments out there (i-bonds, long-term CDs with small withdrawal penalties) that offer comparable after-tax returns without tying up your principal. If interest rates go down, you could refi at an even lower rate (so if you pay cash, you eliminate that option). And if you expect interest rates to rise over the coming years, then having a fixed mortgage at 3.6% with tax-deductible interest might look pretty good if savings accounts, CDs etc are paying at higher rates.

I've found the Bogleheads forum to be a good place to hear all sides of issues like these...there are a number of threads on this issue. Their wiki also has this article.
posted by alexfw at 7:38 AM on July 11, 2012

A couple of things:

The mortgage deduction isn't always a big deal, depending in the size of the mortgage, your overall tax situation, etc. Do the math, but in my case the benefit is so trivial as to become negligible.

An advantage of a paid off mortgage is cashflow. Regardless of interest rates and financial projections, owning the house means you have control over a sizeable portion of your monthly budget that you can invest, spend, or whatever.

My mortgage interest rate is under what you are looking at, and even so if I had the cash in hand I would pay it off today simply because of the flexibility it would give me. One question you might want to look into, though, is what impact this decision would have on college student financial aid calculations. There might be significant advantages or disadvantages at that point of being more or less leveraged, for example.
posted by Forktine at 7:42 AM on July 11, 2012

You need to do a cost-benefit analysis with the opportunity cost of taking a mortgage. If you are not able to do this, then you should not be making this decision by yourself (especially with only going for the advice of your financial friends) and should be looking for independent third party assistance - ie, a fee-based financial advisor. This is not a bad thing and says nothing about you beyond that financial decisions that cost hundreds of thousands of dollars should be made very carefully.

You are focusing too closely on the potential 3.6% return of paying off your mortgage. Here are the costs associated with taking that:
  • If you think the financial market is heading towards volatility and uncertainty, there is also a likelihood (although certainly not guarantee, as we've seen) that the housing market will similarly be volatile and uncertain. Note that many Americans have a habit of keeping retirement assets in their house, so when they retire, they have to liquidate their house if their other retirement assets are not valuable (ie, if the market crashes). Hence, there is a downward pressure in prices as people retire. If you have a mortgage, you can simply walk away from your home as a financial decision if this happens. You might not like that as a person, but you should not be looking at this as a morality question.
  • There is value in having liquid cash or easily liquidized assets in your residual 50% savings. If you believe in market volatility, cash is what you want. In particular, if you think you will lose your job, you want cash. However, if the liquidized portion of your residual 50% savings is much greater than the cost of losing your job, this is not that important. That said, there is a (small, but non-zero) monetary advantage in having cash around
  • You should not be comparing the 3.6% return vs a 6% return on an index fund. The real return of an investment is the actual return reduced by your marginal tax rate multiplied by the portion of the investment that is taxed. The real return of paying your mortgage is reduced by the amount the mortgage would reduce your taxes if you had it. I am deliberately not filling in these numbers to bias you because depending on your tax scenario, we could end up with wildly differing numbers. If you want to make this decision, you should be able to fill in those numbers by yourself without my help.
  • There is monetary value in not making mortgage payments. People like you (and me) tend to hate making payments. How much do you value that? You can account for some of the monetary losses in paying off the mortgage by the monetary value of not making payments. It sounds odd to put a monetary value on something you think, but that's how you should be approaching this.
I think that anyone here that says "take the mortgage" or "pay the mortgage" unconditionally is making a decision with too little information. As I've noted, there is tremendous variation in how this works out depending on your perception of the market and your current tax situation. Only you can figure this out. If you can't figure it out, don't do it.
posted by saeculorum at 7:43 AM on July 11, 2012 [5 favorites]

The other 50% is fairly liquid, with an even spread between 401k

Just to be clear, none of the cash for the house would come out of a retirement account, right?
posted by yerfatma at 7:51 AM on July 11, 2012 [2 favorites]

If I were you, I'd put 50% down and invest the rest.

This assumes that you're frugal enough that you save a big chunk of your monthly income (and the fact that you're able to pay for a house in cash suggests that you are) and that your income is stable and will likely be stable for the foreseeable future.

The nice thing about taking out the mortgage now is that you can put some of that money into more conservative investments until things sort themselves out and then either invest in something for the longer term or pay off the mortgage. There might be some kind of early payment penalty so you will want to ask your mortgage professional about it. If you think that you'll probably have to pay off the mortgage sooner, you might shop around a bit and try to get lower closing costs even if you end up with a slightly higher rate.

You can always do a cash-out refi later but it is much more difficult (many lenders simply won't do it) and you might not be able to get a rate this low ever again.

For the funds that will either be invest in the house or put into other investments via the mortgage I would assume that you'll need to access that money when your kids go to college (it might be true but it seems like the most likely worst-case-scenario) and work with that as you time-horizon rather than the length of the mortgage. With that in mind, you have a long enough time-horizon that you can tolerate a fair amount of risk.
posted by VTX at 9:37 AM on July 11, 2012

One other thing worth considering is that a all-cash offer is a good opportunity to exert some negotiatingp ower. Since you don't go have to go through the bank hurdles, and don't need contingencies on your offer, it's less work for the seller's realtor. They should be more inclined to push the offer, perhaps even to the point of cutting their commission.

All-cash offers, essentially, give you the power to buy the house at a discount, and (obviously) to save on the costs of originating a mortgage. That's something like a 5%-8% discount, immediately.

Cheap debt and leverage are valuable, but so is locking in a savings like that -- particularly if you expect interest rates and investment returns to stay low. In a soft market I personally wouldn't want to overleverage. (Obviously, no one knows the future.)
posted by zvs at 9:58 AM on July 11, 2012 [3 favorites]

We bought earlier this year with cash. It represented about 1/3 of our reserves not 50%. And echoing zvs, we easilty negotiated a deal 15% off of the asking price (which was actually a good price to begin with). And our closing costs, in entirety, were $710 dollars. We don't regret our decision at all.
posted by kimdog at 10:31 AM on July 11, 2012

I'm thinking that the way to frame the math problem here is:

What do I pay in interest by taking the loan?

What would the tax break be by taking the loan?

If the tax break is higher than the interest. Finance.

If the interest is higher than the tax break. Pay cash.

Did I miss anything here?
posted by Ruthless Bunny at 1:18 PM on July 11, 2012

I have a very large mortgage at a very low interest rate and find that it still makes sense to take the standard deduction rather than to itemise to claim mortgage interest deduction. As has been noted elsewhere above, the deduction is nice but it's not a like-for-like replacement for the money paid in interest, and you're not necessarily better off by taking the mortgage interest deduction. From the link above, MFJ couples get $11900 standard. You can have that for free, never mind the savings from the mortgage interest deduction. This is something to bear in mind if you went the 50% route especially. If you're not paying $1000 a month in interest, it may not be worth itemising. If it's not worth itemising for the deduction, it might not be worth taking out the mortgage.
posted by sagwalla at 1:59 PM on July 11, 2012

I'd take the mortgage as a 30 year fixed. 3.6% is a crazy cheap loan. After the mortgage tax deduction the real rate to you is more like 2.4% (assuming 35% tax bracket).

Those are some hefty assumptions. First, to be in the 35% tax bracket, the OP, filing jointly, would have an adjusted gross income above $390,000, with no state income tax (OP is in Texas).

Second, the standard deduction is $11,900 for a couple which means that they wouldn't even start getting a mortgage deduction until their total deductions exceed that amount. Austin has property taxes in the neighborhood of 2% so the mortgage deduction only applies, roughly, to the portion of the mortgage greater than about $200,000, unless they have other large deductions. So, it is quite possible that they get little or no mortgage deduction at all. You have to run the real numbers, but they are likely not anything near to your off-the-cuff estimate.

There is a tendency to oversell the mortgage deduction for middle income people, neglecting the fact that the standard deduction has increased dramatically in recent decades.
posted by JackFlash at 4:00 PM on July 11, 2012

Best answer: Did I miss anything here?

1- Yes. The tax break is always less than the interest you pay because the tax break is a percentage of the interest you pay.

2- The question is whether to take the money they were going to spend on the house and invest it in something else that would make more interest than they would pay on the mortgage. Very simply, if you have a mortgage at 3.6%, and you can somehow find an investment that pays 4% a year, then it allegedly makes sense to do that instead of just paying cash for the house.

However, it usually doesn't end up working out. Money, investments and risk, like water, have a funny way of finding their own level. If that other investment that's making the 4% was really as low-risk as a mortgage, the people lending you the money for the mortgage would be investing in that instead. They would be stupid to take your 3.6% when they can take that other person's 4%. But they aren't, so it must be higher risk than you think.

I figured it out once. Start with $100,000 and no house. Choice one is to buy the house for cash, and then put $1000 a month into a bank account. Choice two is to get a mortgage, pay the bank $1000 a month, and invest the $100,000. There were a couple of narrow scenarios where choice two won out (specific time horizons, I think), but in general, choice one always won. Because over time, you got to "keep" the interest you would send the bank, but you then also could invest the money you were saving each month into your get rich quick scheme.
posted by gjc at 6:36 PM on July 12, 2012

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