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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). Meanwhile, a recent index from the NAR showed 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.
- Why you should consider paying cash for a house
- Why you should consider getting a mortgage
- Things to keep in mind before closing your home purchase
Why you should consider paying cash for a house
One of the primary reasons to pay cash for a house is owning 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 cashflow 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 makes 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.
Why you should 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. We cover the specifics of these changes in our guide to the 2018 mortgage interest deduction.
Things to keep in mind before closing your home purchase
Consider other financial goals, like retirement, college savings plans and more. If you’re not solid with your other savings, you may not want to tie up a large amount of money in real estate. If you have the money, and plenty left over to cover the associated taxes, fees and maintenance costs, it may be worth buying the home in cash, especially if you want to increase the amount of cash you have on hand from month to month. The interest and fees that accompany mortgages — not to mention the often lengthy approval and closing process — can be avoided if you have the ability to purchase the property outright.
Make sure you have enough cash to cover you through at least several months of expenses; if your financial situation changes, you may need access to funds. While you would have the option to access cash from the equity of your home, it still takes a few weeks to process a home equity loan or home equity line of credit (commonly called a HELOC). It's generally recommended that families have 3 – 6 months worth of living expenses saved up in a high-yield savings account. If buying a property with cash would completely wipe out your savings, this could increase your risk should a major life event such as a job loss or hospitalization occur. It's important that you maintain a basic level of savings to cover unexpected costs that come your way.
How long does it take to breakeven?
Another consideration with getting a mortgage is figuring out how long it takes to earn back your closing costs through a home sale. The upfront costs associated with buying a home — such as real estate attorney and agent fees, government taxes and inspection costs — don’t make much sense if you’re not planning to hold on to the property. For instance, If you’re planning to move within five years or so, the house may not have a chance to appreciate in value. That means if you choose to sell it, you may not make back the money you paid for the home (not to mention the incremental interest and closing costs).
Mortgages are front-loaded amortizing loans, which means that most of the interest you pay will be in the first few years of the loan, while you're unlikely to make a real dent in your principal until 10 or 15 years in (to a 30 year mortgage). It's a good idea to use a mortgage calculator to estimate how long it will take you to breakeven on your mortgage.
How hot is the market?
Finally if you find yourself in a hot real estate market and on the verge of a bidding war, you may want to consider a full cash offer as an opportunity to close the deal quickly. If two of the same offers are placed on the table and one is a cash offer while the other requires financing, home sellers will overwhelming prefer the cash offer due to the certainty that cash offers. There's always the chance that a buyer may be rejected at the last minute by a mortgage lender.
The information in this article is accurate as of the date of publishing.