Paying Cash for a Home Versus Mortgage
February 28, 2024 10:55 PM Subscribe
Does it make more sense to pay cash for a house or take out a mortgage with a large down payment? Is my analysis correct?
I am trying to figure out if it makes more sense to pay cash for a home or take out a mortgage with a large down payment. My general conclusion so far seems to indicate that if my wife and I can swing the cash payment it makes the most sense unless interests rates drop significantly enough to refinance at a significantly lower rate (essentially a bet on interest rates). Mortgage rates are around ~7% for a 30 year, 6.38% for a 15 year, and 6.57% for a 10 year.
The house we are under contract for is $670,000. After saving for many years we have enough cash in post-tax non-retirement accounts that we can cover this directly and retain a reasonable emergency fund though it may get tighter than I usually like if we do any large renovations. We likely wouldn’t need to sell any securities and pay capital gains taxes.
It seems like we can pay cash but is it smart to? Is taking a mortgage with a large down payment a better option? It seems unless the investment rate of return that we could achieve with the cash is significantly higher than the mortgage interest rate it makes more sense to pay cash for the house (ignoring refinancing). Is this correct view point?
Some other pertinent information:
Family: We have one small child and are expecting another shortly. We might put the kids in day care in a few years and my wife might
Retirement Age: We are in our mid-forties and ideally, I would like to retire in 10 years though it may stretch to 15.
Tax Bracket: 22%
Tax Deductions: Usually we take the standard deduction. The property taxes on the house are likely going to be in the range of ~$10,000 to $12,000. The SALT deduction cap would be $10,000.
Other investments: We have other retirement and non-retirement investments than what we would be using to potentially pay for the house.
If we were to take out a mortgage I would like to keep the monthly payment less than $3,500 including the mortgage principal and interest payments, property taxes, and home insurance. I am assuming ~$1,500 for property taxes and home insurance. Therefore, a maximum mortgage payment towards interest and principal ideally would be around ~$2000. To keep the payment interest and principal payment around $2000 would likely require a substantial down payment (minimum 54% down payment $361,800 for 30 year, 64% down payment $428,800 for 15 year , and 73% down payment $489,100 for 10 year mortgages).
To deduct the mortgage interest, it seems like the down payment would need to be less than the following percentages: 59% down payment, 30 year; 54% down payment, 15 year; 54% down payment, 10 year. At the mortgage interest near these down payment levels would only allow for itemized deduction for a few years. Any down payment percentage greater than above it makes sense to use the standard deduction. The down payment percentage would also need to be significantly lower than the above percentages to take advantage of itemized deductions for many subsequent years. Does that make sense? The tradeoff of course going with a lower down payment is the increase in the monthly payment and the amount of interest paid overall. It doesn’t seem like to me the deduction of the interest ever makes up for the increase in interest paid as the down payment percentage is lowered.
I tried to do a more detailed analysis using a range of expected rates of returns and I wanted to make sure my analysis makes sense and I am not missing anything. Basically, what I am trying to compare is the following:
(Assumed investment returns from cash offset by loan amount – loan payments) compared to investing the same amount monthly as the mortgage payments.
As an example assuming a 10 year mortgage and 70% down payment of $469,000 and loan of $201,000 allows the cash of $201,000 to be invested. Assuming an investment rate of return of 7% results in an end balance (contributions + returns) after 10 years of $395,397.42.
However, we would need to make mortgage payments of $2,289 per month for 10 years for a total of $274,738. The difference would the overall positive gain from taking the mortgage, of $395,397.42 - $274,738 = $120,659.85.
If instead of taking out the loan of $201,000 we fully pay cash for the house and invest the payment we would be making towards the mortgage at an assumed 7% return rate would give an end balance of $391,537.41. This is substantially higher than the option of taking out the loan and investing the cash we have on hand ($391,537.41 - $120,659.85 = $270,877.56. Unless a very high rate of return is assumed it seems like paying cash will pretty much always come out ahead.
Is there some fatal flaw in the way I am trying to do the analysis? I guess what would change the conclusion is refinancing at a much lower interest rate.
What real rate of return would you assume for investing the cash instead but accounting for tax drag? A 10% per year return is sort of assumed for the stock market but that does not account for taxes and inflation. I assume 7% might be a more realistic rate of return.
I am trying to figure out if it makes more sense to pay cash for a home or take out a mortgage with a large down payment. My general conclusion so far seems to indicate that if my wife and I can swing the cash payment it makes the most sense unless interests rates drop significantly enough to refinance at a significantly lower rate (essentially a bet on interest rates). Mortgage rates are around ~7% for a 30 year, 6.38% for a 15 year, and 6.57% for a 10 year.
The house we are under contract for is $670,000. After saving for many years we have enough cash in post-tax non-retirement accounts that we can cover this directly and retain a reasonable emergency fund though it may get tighter than I usually like if we do any large renovations. We likely wouldn’t need to sell any securities and pay capital gains taxes.
It seems like we can pay cash but is it smart to? Is taking a mortgage with a large down payment a better option? It seems unless the investment rate of return that we could achieve with the cash is significantly higher than the mortgage interest rate it makes more sense to pay cash for the house (ignoring refinancing). Is this correct view point?
Some other pertinent information:
Family: We have one small child and are expecting another shortly. We might put the kids in day care in a few years and my wife might
Retirement Age: We are in our mid-forties and ideally, I would like to retire in 10 years though it may stretch to 15.
Tax Bracket: 22%
Tax Deductions: Usually we take the standard deduction. The property taxes on the house are likely going to be in the range of ~$10,000 to $12,000. The SALT deduction cap would be $10,000.
Other investments: We have other retirement and non-retirement investments than what we would be using to potentially pay for the house.
If we were to take out a mortgage I would like to keep the monthly payment less than $3,500 including the mortgage principal and interest payments, property taxes, and home insurance. I am assuming ~$1,500 for property taxes and home insurance. Therefore, a maximum mortgage payment towards interest and principal ideally would be around ~$2000. To keep the payment interest and principal payment around $2000 would likely require a substantial down payment (minimum 54% down payment $361,800 for 30 year, 64% down payment $428,800 for 15 year , and 73% down payment $489,100 for 10 year mortgages).
To deduct the mortgage interest, it seems like the down payment would need to be less than the following percentages: 59% down payment, 30 year; 54% down payment, 15 year; 54% down payment, 10 year. At the mortgage interest near these down payment levels would only allow for itemized deduction for a few years. Any down payment percentage greater than above it makes sense to use the standard deduction. The down payment percentage would also need to be significantly lower than the above percentages to take advantage of itemized deductions for many subsequent years. Does that make sense? The tradeoff of course going with a lower down payment is the increase in the monthly payment and the amount of interest paid overall. It doesn’t seem like to me the deduction of the interest ever makes up for the increase in interest paid as the down payment percentage is lowered.
I tried to do a more detailed analysis using a range of expected rates of returns and I wanted to make sure my analysis makes sense and I am not missing anything. Basically, what I am trying to compare is the following:
(Assumed investment returns from cash offset by loan amount – loan payments) compared to investing the same amount monthly as the mortgage payments.
As an example assuming a 10 year mortgage and 70% down payment of $469,000 and loan of $201,000 allows the cash of $201,000 to be invested. Assuming an investment rate of return of 7% results in an end balance (contributions + returns) after 10 years of $395,397.42.
However, we would need to make mortgage payments of $2,289 per month for 10 years for a total of $274,738. The difference would the overall positive gain from taking the mortgage, of $395,397.42 - $274,738 = $120,659.85.
If instead of taking out the loan of $201,000 we fully pay cash for the house and invest the payment we would be making towards the mortgage at an assumed 7% return rate would give an end balance of $391,537.41. This is substantially higher than the option of taking out the loan and investing the cash we have on hand ($391,537.41 - $120,659.85 = $270,877.56. Unless a very high rate of return is assumed it seems like paying cash will pretty much always come out ahead.
Is there some fatal flaw in the way I am trying to do the analysis? I guess what would change the conclusion is refinancing at a much lower interest rate.
What real rate of return would you assume for investing the cash instead but accounting for tax drag? A 10% per year return is sort of assumed for the stock market but that does not account for taxes and inflation. I assume 7% might be a more realistic rate of return.
The main reason for financing a house at current interest rates rather than buying it outright is to avoid tying up all your cash in an illiquid investment. As you point out, it will cost you some $ for that liquidity. I would personally assume about 6% for stock market returns over 10 years, as it's probably the shortest time horizon for 'long term'.
I think the answer really is how big your remaining savings are compared to your likely needs/risks. One of the challenges is that if you are in a real financial crisis your ability to borrow against your house may be impaired or non-existent.
If it's helpful to hear other people's approaches, I'm anticipating putting a about two-thirds of my non-retirement savings into reducing the mortgage on my house in the next couple of months.
posted by plonkee at 1:01 AM on February 29
I think the answer really is how big your remaining savings are compared to your likely needs/risks. One of the challenges is that if you are in a real financial crisis your ability to borrow against your house may be impaired or non-existent.
If it's helpful to hear other people's approaches, I'm anticipating putting a about two-thirds of my non-retirement savings into reducing the mortgage on my house in the next couple of months.
posted by plonkee at 1:01 AM on February 29
If you put $670,000 cash into your house, put $2289/mo into investments yielding 7% per annum, and build a portfolio worth $393,209 (per my calculations) in 2034, you have $118,529 of capital gains.
If you put $469,000 cash into your house and $201,000 into the market now at 7% per annum, pay $2289/mo to your lender, and build a portfolio worth $395,397 in 2034, you have $194,397 of capital gains. If those gains are taxable when realized, you could be five figures worse off.
In either case, you have paid $944,680 for a ~$395K portfolio and a house. But only if rates hold steady for the next decade would this analysis apply.
If inflation stabilizes around 2% and interest rates fall, you would be much better off either holding bonds locked in with today's interest rates or retaining cash to invest in a rising stock market while refinancing your mortgage at a rate lower than your portfolio would yield.
If interest rates continue to rise, you would be much better off having cash in hand and a mortgage at today's current rates. This looks improbable, but it's another downside of draining liquidity. Emptying the piggy bank prevents capitalizing on a shifting market.
I am not going to speculate about your own after-tax yield. That's for your own tax professional.
posted by backwoods at 4:17 AM on February 29 [4 favorites]
If you put $469,000 cash into your house and $201,000 into the market now at 7% per annum, pay $2289/mo to your lender, and build a portfolio worth $395,397 in 2034, you have $194,397 of capital gains. If those gains are taxable when realized, you could be five figures worse off.
In either case, you have paid $944,680 for a ~$395K portfolio and a house. But only if rates hold steady for the next decade would this analysis apply.
If inflation stabilizes around 2% and interest rates fall, you would be much better off either holding bonds locked in with today's interest rates or retaining cash to invest in a rising stock market while refinancing your mortgage at a rate lower than your portfolio would yield.
If interest rates continue to rise, you would be much better off having cash in hand and a mortgage at today's current rates. This looks improbable, but it's another downside of draining liquidity. Emptying the piggy bank prevents capitalizing on a shifting market.
I am not going to speculate about your own after-tax yield. That's for your own tax professional.
posted by backwoods at 4:17 AM on February 29 [4 favorites]
Another aspect in addition to liquidity is exposure / risk. Paying cash is, risk wise, like putting that money into an REIT. Your overall portfolio will be very RE- heavy, and that has very different risks (see: 2008) than a stick market index fund.
posted by Dashy at 4:20 AM on February 29
posted by Dashy at 4:20 AM on February 29
There are many good comments about the analysis, so here's another thought: you don't say anything about where you are under contract or the type of house. Different people have different risk tolerances and life expectations, but many growing U.S. cities are located in areas that were never going to be sustainable at any scale, let alone when people are migrating there in inverse proportion to its natural resources. Likewise, many houses were not built for a warming world, or for one with unstable weather or power grid disruptions. Is the house going to maintain its value to and through retirement? I'm not talking about ConAgBoeCraft unexpectedly pulling out and decimating the local economy, but "are people going to want to buy this house, in this place, in 10-30 years?" It's hard to know exactly where the breaking point is for individual cities, but certainly it's something that people are thinking about for the future.
Sorry if that feels like a doomer response! I'm not trying to be, just saying it's something that I have thought about, and I have often encountered people who don't think about it, or at least don't seem to think about it in ways that affect their home renting/buying decisions.
posted by cupcakeninja at 5:08 AM on February 29 [1 favorite]
Sorry if that feels like a doomer response! I'm not trying to be, just saying it's something that I have thought about, and I have often encountered people who don't think about it, or at least don't seem to think about it in ways that affect their home renting/buying decisions.
posted by cupcakeninja at 5:08 AM on February 29 [1 favorite]
If you can buy the house with cash, buy it with cash, since all cash offers are so much more competitive. From there, take a breath and figure out if you want a mortgage or not.
posted by rockindata at 5:28 AM on February 29
posted by rockindata at 5:28 AM on February 29
Response by poster: To answer a few of the questions that have arisen.
@plonkee, If we pay cash we will still have decent size retirement and non-retirement investment accounts (~$2 million).
@Backwoods, you are correct that I have forgotten to account for capital gains on invested returns. That may alter some of my analysis. The option where I put $670,000 cash into the house may allow me to put some of the $2289 from my salary into tax advantaged accounts like a 457(b). I don't think I could do that with the cash I already have saved.
@Backwoods, couldn't I view the mortgage as a bond or treasury that pays ~7% that is locked in?
@cupcakeninja and @rockindata, we are under contract and at this point we are down to the wire timing wise if we want to go the mortgage route. The house is in an area which is less likely to have severe effects from climate change.
posted by cycleback at 5:48 AM on February 29 [1 favorite]
@plonkee, If we pay cash we will still have decent size retirement and non-retirement investment accounts (~$2 million).
@Backwoods, you are correct that I have forgotten to account for capital gains on invested returns. That may alter some of my analysis. The option where I put $670,000 cash into the house may allow me to put some of the $2289 from my salary into tax advantaged accounts like a 457(b). I don't think I could do that with the cash I already have saved.
@Backwoods, couldn't I view the mortgage as a bond or treasury that pays ~7% that is locked in?
@cupcakeninja and @rockindata, we are under contract and at this point we are down to the wire timing wise if we want to go the mortgage route. The house is in an area which is less likely to have severe effects from climate change.
posted by cycleback at 5:48 AM on February 29 [1 favorite]
A mortgage is much like a bond with a locked-in rate of return, but only for the lender, not the borrower. If you take out a mortgage instead of paying cash, the lender gains certainty and you gain flexibility. It is almost the inverse of holding $200,000 in long-term bonds. Except for the tax implications which I am not qualified to evaluate.
posted by backwoods at 6:17 AM on February 29 [1 favorite]
posted by backwoods at 6:17 AM on February 29 [1 favorite]
This is a minor point, but I really appreciate having my mortgage bank manage escrows. It's easy for me to remember to do something once a month but not so easy to remember twice a year (property taxes) or once a year (insurance). Even if I were going to pay cash for a house I'd be tempted to carry a wee mortgage just for that budgeting feature.
posted by eraserbones at 6:33 AM on February 29 [2 favorites]
posted by eraserbones at 6:33 AM on February 29 [2 favorites]
There are a few additional advantages, financial and non-financial, to paying cash that are worth considering. One is the savings of not needing to pay any of the fees (like mortgage origination fees) that go along with a mortgage and any future refinance (and also not needing to deal with the hassle of having your mortgage get sold, then resold, then resold again). The advantage of paying cash in terms of an attractive offer was mentioned, but it sounds like you are under contract already so this isn't a factor. The biggest thing that matters to some people and not others is the security of owning it outright if, say, a few years from now your income dropped way down for some reason. On paper this is no different from having a big chunk of money in savings that you could use to pay the mortgage, but those feel quite different psychologically. Again, this matters to some people but not everyone.
Personally, we chose to pay cash for our current house, partly for the ease of the transaction but largely for the various non-financial elements. We'll only know in hindsight, but 'm completely fine if it turns out that it wasn't the most financially optimal approach. (The simplicity of the transaction was kind of wild compared to buying with a mortgage, with all the applications and inspections and endless forms to sign. I think I signed maybe five documents, all via my phone, and bam, the transaction was done.)
The potential red flag I see in your description is that paying cash might leave you with an uncomfortably small emergency fund. If that just means that you would need to budget carefully for a kitchen remodel, that's no big deal, but if it meant being vulnerable to not being able to cover routine house expenses like a new furnace, that would not be good. From your additional comment, it sounds like you'd have plenty in reserve, but this is worth thinking through.
posted by Dip Flash at 6:45 AM on February 29 [1 favorite]
Personally, we chose to pay cash for our current house, partly for the ease of the transaction but largely for the various non-financial elements. We'll only know in hindsight, but 'm completely fine if it turns out that it wasn't the most financially optimal approach. (The simplicity of the transaction was kind of wild compared to buying with a mortgage, with all the applications and inspections and endless forms to sign. I think I signed maybe five documents, all via my phone, and bam, the transaction was done.)
The potential red flag I see in your description is that paying cash might leave you with an uncomfortably small emergency fund. If that just means that you would need to budget carefully for a kitchen remodel, that's no big deal, but if it meant being vulnerable to not being able to cover routine house expenses like a new furnace, that would not be good. From your additional comment, it sounds like you'd have plenty in reserve, but this is worth thinking through.
posted by Dip Flash at 6:45 AM on February 29 [1 favorite]
Its not true that the house is totally illiquid, even if you can't/don't want to sell it. If you need money, or if you regret paying cash, you can always mortgage the house later. It's also incredibly easy to get a HELOC when you have 100% equity in the house.
posted by juliapangolin at 7:07 AM on February 29 [2 favorites]
posted by juliapangolin at 7:07 AM on February 29 [2 favorites]
This sort of decision is intensely personal and dependent on each person's goals and situation, but you seem to realize that already. You've considered a lot of things, and you're getting good feedback and analysis here. I want to add one other thing to consider.
@juliapangolin said: It's also incredibly easy to get a HELOC when you have 100% equity in the house.
Home equity is less liquid than nearly anything else. Yes, many folks can qualify for a home-equity loan, but situations can change and this can become less certain. That sounds vague, so let me give you an actual example.
In 2017, at the age of 48, I purchased a $450,000 home with cash. This left me with roughly $400,000 in non-retirement investment accounts. At the time, I earned a couple of thousand per month (variable) from my online ventures. Because I was trying to be semi-retired, this gave me just enough to reach retirement age (59-1/2) based on my levels of spending.
The trouble came when the house needed extensive repairs. $150,000 later and my non-retirement investment accounts had dropped to $250,000. Then my online revenue dropped to only about $500 per month. Suddenly I was at age 51 with half what I needed to get me to retirement age. And I couldn't get a home-equity loan because I didn't have a "real" job with a regular stream of income. Banks don't give a whit that you have enough invested and in the bank to cover a mortgage or home-equity loan; they want to see that you have income to make the payments. I don't know why, but that's the way it is. This situation stressed me the fuck out. Not joking. I was a mess trying to figure out how to get to retirement age.
So, I sold the house, bought a new one with a modest downpayment. Now, at age 55, I have a $400,000 mortgage at 2.6% with $400,000 of non-retirement investments. I have zero worries about making it to 59-1/2. In fact, I'm hopeful that I can make it to 65 (or later) without touching my retirement accounts. Meanwhile, my index funds continue to average a 7% real return while my mortgage is locked in at 2.6%.
Now, I realize a 7% mortgage is vastly different than a 2.6% mortgage. Vastly. But this lack of cash-flow is still something to consider depending on your goals and situation. It's a very real thing. And it's the reason that some us in the early-retirement community push back against the dogmatic "pay off your home before retirement" advice. Sure, that sounds great. We'd all like to do it. But it's not necessarily a panacea. There are plenty of cases where it makes more sense to carry a mortgage, and mine was one of them.
(I will say as an afterthought, however, that @rockindata is right: cash offers on a home are always more competitive. In fact, I had to settle for a second choice home because I lost my top choice — basically my dream house — by not making a cash offer. Mine was the top bid but dependent on qualifying for a mortgage. The second-highest offer won. That still stings. But if I'd won that bid, I'd currently own the house free and clear but have ZERO in non-retirement investments. I'm pleased to be in a lesser home but have the freedom of semi-retirement, thank you very much.)
posted by jdroth at 7:23 AM on February 29 [8 favorites]
@juliapangolin said: It's also incredibly easy to get a HELOC when you have 100% equity in the house.
Home equity is less liquid than nearly anything else. Yes, many folks can qualify for a home-equity loan, but situations can change and this can become less certain. That sounds vague, so let me give you an actual example.
In 2017, at the age of 48, I purchased a $450,000 home with cash. This left me with roughly $400,000 in non-retirement investment accounts. At the time, I earned a couple of thousand per month (variable) from my online ventures. Because I was trying to be semi-retired, this gave me just enough to reach retirement age (59-1/2) based on my levels of spending.
The trouble came when the house needed extensive repairs. $150,000 later and my non-retirement investment accounts had dropped to $250,000. Then my online revenue dropped to only about $500 per month. Suddenly I was at age 51 with half what I needed to get me to retirement age. And I couldn't get a home-equity loan because I didn't have a "real" job with a regular stream of income. Banks don't give a whit that you have enough invested and in the bank to cover a mortgage or home-equity loan; they want to see that you have income to make the payments. I don't know why, but that's the way it is. This situation stressed me the fuck out. Not joking. I was a mess trying to figure out how to get to retirement age.
So, I sold the house, bought a new one with a modest downpayment. Now, at age 55, I have a $400,000 mortgage at 2.6% with $400,000 of non-retirement investments. I have zero worries about making it to 59-1/2. In fact, I'm hopeful that I can make it to 65 (or later) without touching my retirement accounts. Meanwhile, my index funds continue to average a 7% real return while my mortgage is locked in at 2.6%.
Now, I realize a 7% mortgage is vastly different than a 2.6% mortgage. Vastly. But this lack of cash-flow is still something to consider depending on your goals and situation. It's a very real thing. And it's the reason that some us in the early-retirement community push back against the dogmatic "pay off your home before retirement" advice. Sure, that sounds great. We'd all like to do it. But it's not necessarily a panacea. There are plenty of cases where it makes more sense to carry a mortgage, and mine was one of them.
(I will say as an afterthought, however, that @rockindata is right: cash offers on a home are always more competitive. In fact, I had to settle for a second choice home because I lost my top choice — basically my dream house — by not making a cash offer. Mine was the top bid but dependent on qualifying for a mortgage. The second-highest offer won. That still stings. But if I'd won that bid, I'd currently own the house free and clear but have ZERO in non-retirement investments. I'm pleased to be in a lesser home but have the freedom of semi-retirement, thank you very much.)
posted by jdroth at 7:23 AM on February 29 [8 favorites]
Its not true that the house is totally illiquid, even if you can't/don't want to sell it. If you need money, or if you regret paying cash, you can always mortgage the house later. It's also incredibly easy to get a HELOC when you have 100% equity in the house.
This. With rates as high as they are, expecting a stock market return to beat it is not very realistic. Most people simply cannot pay cash for a home, so mortgages are a thing. If rates fall, then a HELOC or home equity line of credit might be a good idea. At 3% a mortgage is a no-brainer.
Also the tax implications of owning a home, like you point out, are very temporary and only available at high mortgage amounts. Maxing out your 401k, for example, is a far better tax strategy than paying more for a mortgage to get a tax break.
posted by The_Vegetables at 7:23 AM on February 29 [1 favorite]
I like not having a mortgage, but it also means I have to make sure the homeowner's insurance is paid, and the property tax. Homeowner's can be a pain; a company canceled my insurance while I was traveling, and I was uninsured for a couple months because I didn't get mail promptly. Now I check it online when I pay my property taxes twice a year. It sounds like the mortgage tax deduction isn't particularly useful to you.
posted by theora55 at 7:25 AM on February 29 [1 favorite]
posted by theora55 at 7:25 AM on February 29 [1 favorite]
A small separate comment to push back against the "HELOCs are easy" crowd. They may be easy for most people, but they're still not guaranteed even if you own the home free and clear. I managed to get one two houses ago despite not having a traditional job, but the bank was reluctant to grant the loan (like, they actually interviewed me in person) and they had an upper limit on what they'd give me ($100,000). If you think you'll work until 65, great. A HELOC should be a piece of cake. But if not, then it might not be so easy to get.
posted by jdroth at 7:28 AM on February 29
posted by jdroth at 7:28 AM on February 29
The asker says they have ~$2 million in other accounts besides the house money. I don't think access to a HELOC is going to be a critical factor in this decision, versus a situation where accessible savings are limited.
Maxing out your 401k, for example, is a far better tax strategy than paying more for a mortgage to get a tax break.
This. If the asker is able to bump their tax-advantaged savings way up by not having a mortgage, I'm reasonably certain that this alone would tip the financial balance towards paying cash vs having the mortgage. (Again, acknowledging that financial considerations are only a part of the decision.)
posted by Dip Flash at 7:42 AM on February 29 [1 favorite]
Maxing out your 401k, for example, is a far better tax strategy than paying more for a mortgage to get a tax break.
This. If the asker is able to bump their tax-advantaged savings way up by not having a mortgage, I'm reasonably certain that this alone would tip the financial balance towards paying cash vs having the mortgage. (Again, acknowledging that financial considerations are only a part of the decision.)
posted by Dip Flash at 7:42 AM on February 29 [1 favorite]
Based on your age and circumstances, my vote is for a mortgage.
I think you're possibly underfunding major categories such as kids education, emergency fund, and retirement. You mentioned you still have room to contribute to your 457b. You're right that you can't deposit your existing money into the 457b, but you can max it out and pull from your savings to cover expenses achieving the same thing.
Also, you didn't mention if your income covers your expenses. With a growing family, having the extra $ will give your family flexibility if a spouse needs to stay home or if you need to change jobs.
posted by jraz at 7:47 AM on February 29
I think you're possibly underfunding major categories such as kids education, emergency fund, and retirement. You mentioned you still have room to contribute to your 457b. You're right that you can't deposit your existing money into the 457b, but you can max it out and pull from your savings to cover expenses achieving the same thing.
Also, you didn't mention if your income covers your expenses. With a growing family, having the extra $ will give your family flexibility if a spouse needs to stay home or if you need to change jobs.
posted by jraz at 7:47 AM on February 29
Just to note that the higher your down payment, the less leveraged you start out. One of the advantages/unusual features of a mortgage is that it's just about the most leveraged investment instrument available to ordinary people without jumping through a number of hoops, and leverage increases both potential returns and potential losses on the value of the leveraged asset (here's an explanation, ignore the ads). Counterintuitively, then, assuming an increase in values, the return will be greater for a loan with a higher loan-to-value ratio.
I'm adding this mostly for completeness as you seem interested in the math. I don't think it should, by itself, overcome the important, if sometimes competing, other factors to consider that people have discussed above.
HELOCs are really not guaranteed to be available, though. They did quite poorly in the last downturn and so they're most likely to be inaccessible when you might need them most. And 6.5% isn't forever, but unless you do a big cash-out refinance your low LTV will be. Of course, people do do those, but they can be relatively expensive (though usually not as much as taking a cash advance from a credit card, for instance) and they're less likely to be available in times of personal financial stress.
posted by praemunire at 7:51 AM on February 29
I'm adding this mostly for completeness as you seem interested in the math. I don't think it should, by itself, overcome the important, if sometimes competing, other factors to consider that people have discussed above.
HELOCs are really not guaranteed to be available, though. They did quite poorly in the last downturn and so they're most likely to be inaccessible when you might need them most. And 6.5% isn't forever, but unless you do a big cash-out refinance your low LTV will be. Of course, people do do those, but they can be relatively expensive (though usually not as much as taking a cash advance from a credit card, for instance) and they're less likely to be available in times of personal financial stress.
posted by praemunire at 7:51 AM on February 29
They did quite poorly in the last downturn and so they're most likely to be inaccessible when you might need them most.
That's basically impossible to say. During the last downturn, unemployment only surged to about 10%, and over half of that was people who earn below the median US wage. Those people do not have access to the funds to buy a home in cash, and currently *barely* have access to buy one on credit. In other words, assuming the factors that drive job loss and credit access during major downturns are the same ones that impact individual high earners is impossible to say.
Also, the ones who lost homes during the last downturn, the majority suffered job loss as the culminating factor, not financial irresponsibility, as down payments slightly fell as percents of mortgage, but increased in terms of actual cash outlaid, primarily as a factor of rising home prices.
It's basically equally as likely that this particular person will be able to buy 2-3 homes in cash during the next downturn if they chose to do so as it is they will lose their home.
posted by The_Vegetables at 11:34 AM on February 29
That's basically impossible to say. During the last downturn, unemployment only surged to about 10%, and over half of that was people who earn below the median US wage. Those people do not have access to the funds to buy a home in cash, and currently *barely* have access to buy one on credit. In other words, assuming the factors that drive job loss and credit access during major downturns are the same ones that impact individual high earners is impossible to say.
Also, the ones who lost homes during the last downturn, the majority suffered job loss as the culminating factor, not financial irresponsibility, as down payments slightly fell as percents of mortgage, but increased in terms of actual cash outlaid, primarily as a factor of rising home prices.
It's basically equally as likely that this particular person will be able to buy 2-3 homes in cash during the next downturn if they chose to do so as it is they will lose their home.
posted by The_Vegetables at 11:34 AM on February 29
Accountant here. My advice to clients, "Your two main sources of real grief are your landlord and your bank. The faster you get rid of them, the happier you will be."
It's not your spouse pushing you out the door to go earn money - it's the bank. If you need the funds, then the bank is a great partner - they are always happy to be paid out. But if not - those monthly payments are a constant nag.
posted by Barbara Spitzer at 2:21 PM on February 29 [1 favorite]
It's not your spouse pushing you out the door to go earn money - it's the bank. If you need the funds, then the bank is a great partner - they are always happy to be paid out. But if not - those monthly payments are a constant nag.
posted by Barbara Spitzer at 2:21 PM on February 29 [1 favorite]
That's basically impossible to say.
...no, it's not, because it's actually happened. HELOC securitizations defaulted plenty in 2008 (though they didn't perform as poorly as closed-end second liens). In response, many banks froze HELOC lines. They more or less stopped securitizing them, the market got so bad.
This was not really a question of individual behavior at all (although some people made themselves more vulnerable in various ways), but the entire market jamming up due to a combination of predatory behavior and bad information. As with so many operations of capitalism, starting with what "stands to reason" unfortunately doesn't get you too far in understanding what's actually going on.
Also, the ones who lost homes during the last downturn, the majority suffered job loss as the culminating factor, not financial irresponsibility, as down payments slightly fell as percents of mortgage, but increased in terms of actual cash outlaid, primarily as a factor of rising home prices.
If you think the absolute amount of a down payment affects the risk of a mortgage more than the LTV, you're just wrong about how mortgage default risk works.
Fortunately, that doesn't matter excessively here. You can't default on a mortgage if you don't have one. You can, however, find yourselves in dire financial straits in other ways if you have a sudden need for liquidity, all your money is tied up in home equity, and for whatever reason the banks don't feel like lending. Many of those reasons have nothing to do with "financial irresponsibility," but rather with the broader system you're embedded in--if housing prices are hit in your market as a whole, then you may no longer have whatever margin the bank wants. You just should not assume that you can always get a HELOC or a cash-out refi, especially at a price you want to pay. But, depending on how significant your other assets are, you may not need to plan to rely on one.
posted by praemunire at 3:37 PM on February 29
...no, it's not, because it's actually happened. HELOC securitizations defaulted plenty in 2008 (though they didn't perform as poorly as closed-end second liens). In response, many banks froze HELOC lines. They more or less stopped securitizing them, the market got so bad.
This was not really a question of individual behavior at all (although some people made themselves more vulnerable in various ways), but the entire market jamming up due to a combination of predatory behavior and bad information. As with so many operations of capitalism, starting with what "stands to reason" unfortunately doesn't get you too far in understanding what's actually going on.
Also, the ones who lost homes during the last downturn, the majority suffered job loss as the culminating factor, not financial irresponsibility, as down payments slightly fell as percents of mortgage, but increased in terms of actual cash outlaid, primarily as a factor of rising home prices.
If you think the absolute amount of a down payment affects the risk of a mortgage more than the LTV, you're just wrong about how mortgage default risk works.
Fortunately, that doesn't matter excessively here. You can't default on a mortgage if you don't have one. You can, however, find yourselves in dire financial straits in other ways if you have a sudden need for liquidity, all your money is tied up in home equity, and for whatever reason the banks don't feel like lending. Many of those reasons have nothing to do with "financial irresponsibility," but rather with the broader system you're embedded in--if housing prices are hit in your market as a whole, then you may no longer have whatever margin the bank wants. You just should not assume that you can always get a HELOC or a cash-out refi, especially at a price you want to pay. But, depending on how significant your other assets are, you may not need to plan to rely on one.
posted by praemunire at 3:37 PM on February 29
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Assuming you might also be saving to pay for your children's post-secondary education, it could be worth talking to an accountant who specializes in financial aid to see how these scenarios would affect what kind of support you and your children could get for college loans or other financial assistance. The money you save on interest, for instance, could be used to save towards higher ed costs, but owning a house outright might be a bigger "ding" on financial aid options than if you had a mortgage. Someone who specializes in this may be able to give specific quantitative answers if it is a concern for you.
posted by They sucked his brains out! at 11:36 PM on February 28