Buying Your House Cash or Getting a Loan

[preciseau]

Hello all - just wanted to play out a scenario with you.

If you had the cash to purchase your dream house (Ex. $1M) and still have money left over in the bank, would you do it, or get a loan? Granted, this is not a investment play - this is a house you would plan on living in or keeping in the family for a long time.

Every "expert" who I have spoken with (at least 5 different accountants, tax attorneys and financial advisers) says that it is smarter to get a loan (especially now with the low rates), put down the least amount possible, finance at a fixed rate for as long as you can 30-45 years so you don't get killed if inflation goes up or if hyperinflation happens and the dollar is devalued, then invest the money and try to get a better return than the 3-4% loan amount.

Pros: Write off mortgage interest (might not be able to in the future), still have a TON of cash left over, if someone sues you, they get the house and mortgage, so you really only lose what you paid into the house.

Here is my issue - what if you invest in a highly diversified portfolio and you can't beat 3-4%. Or your investments lose money like how everyone got screwed in 2008 and now you are down 40% when you could have paid off your house. Now you have to go back to work to remake the money you could have used to pay your house off.

Another concern - how would you manage monthly payments and property expenses if your money is tied up in investments? By taking out money, you are messing up the principle investment.

I have run some example numbers. Mortgage on a $1M house financed at around 3% for 30 years, you will end up paying over $2M in the long run. Why pay an extra million? Would a 30 year investment yield more than that?

Even if you pay off your house, you still have to pay for property tax, expenses, insurance, etc. and deal with inflation on your cash.

Sorry for being all over the place with this.

From reading the book, MJ has his house financed (most likely so he can leverage the extra cash).

Also, is it Fastlane to depreciate the property if you classify it as a business asset (39 years)? Corporate headquarters, event venue, etc.

 

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[mohawkdcg]

Hi,
I'm not a financial adviser but can suggest a few more questions to you ask yourself that may help in finding your best answer.

1) Do you expect housing prices in your area to go up or down from here?

2) If your answer is down, what price will the $1M house end up at?

3) For the most part the 'experts' have not seen the future coming, so other than directing them to do what you have determined is best, do you really want to take their advice without a huge grain of salt?

4) If you are worried about getting sued, there are ways to protect your home. For instance do you live in a 'homestead' state?

5) It sounds like $1M is most of your liquidity, so do you want to have all of it tied up in a home and lose your financial flexibility?

6) I don't know what size a $1M house is in your area but do you really need one that large right now?

7) Another way to think about what you are buying is: How much of the $1M is going towards the land (that can vary considerably in price) and how much towards the building (replacement cost if you had to replace it)?

8) The question of paying $2M in interest comes down to this: how hard can you make that money work? If you buy smaller or rent, can you make your cash generate $2M, $10M, $500M, etc. over that time period?

9) Are you OK with the loss of geographical flexibility of owning versus renting? If you have a business that can be run from anywhere then no problem.

If the majority of people and 'experts' end up being wrong as historically happens at major market turns, and we end up with more deflation instead of hyper-inflation, then cash at 0% interest will be growing in purchasing power. And you will have flexibility to take investment deals that may show up in the future.

One idea would be to rent until housing is near a bottom and then buy outright as long as you have cash flow remaining.

 

[preciseau]

Thanks for the detailed response. Regarding where I currently live, California (San Francisco), so no homestead and $1M gets you a ~2K sq. feet fixer with no land and $15K a year in property tax.

 

[Runum]

Historically you could justify tying up 100% cash into your home due to almost guaranteed appreciation. After 2008, not so much.

Not sure how you plan to depreciate whole house. You could depreciate the section of house being used as an office.*

* I am not a CPA or tax attorney. Just thinking out loud.

 

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[The-J]

It'll be a very long time before I buy any house in cash, investment or not, mostly because the lifestyle I seek is a lifestyle that generates income through passive income investments via a large sum of cash tied up in those investments.

20-50% down and a 5 year is the best bet for most Fastlane entrepreneurs. Until I can afford that, I won't own a house. Houses are bad investments unless they generate cash flow.

 

[preciseau]

True - but why throw away money on rent or lease payments when you can have an appreciate asset? Even if it doesn't generate cash flow, you need to live somewhere.

 

[mohawkdcg]

Thanks for the detailed response. Regarding where I currently live, California (San Francisco), so no homestead and $1M gets you a ~2K sq. feet fixer with no land and $15K a year in property tax.

Your welcome and I'm happy if I am helping in some small way. My approach is to estimate my risk with a worse case consequences analysis (WCCA in TMF ). If I estimate the replacement cost of the 2K sqft. house to be < $200K then most of that $1M is paying for a small piece of land. This means the price could drop down close to $200K in a normal free market (1980 prices) and lower in a worse case situation such as a stronger dollar, change in the neighborhood, etc. You'll have to estimate the chances of that happening and decide if you can accept it. I don't know if you follow it but here is a Case-Shiller index of San Francisco housing prices from 1980 to July of this year.



If I had $1M/month coming in it would not even be a consideration, I would just buy the house and not worry about it. If it was going to be an income producing property then I might go for it also. But if it was my whole nest egg, then I would remember that greater flexibility equals lower risk. Today's economic uncertainty makes me want to limit risk and focus on producing income.

 

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[biggeemac]

I financed my house six months ago at about 190k with 3.5 % down and interest rate at 4.25 . It was a no brainer for me. Im not going to use my residence as an investment, but rather as a place to live. My family was renting a two bed 1200 sq ft apartment for the same price. We now live in a five bed 2900 sq ft house on a third of an acre. I dont have any regrets. Housing prices in the dallas area have fluctuated very little during the housing crisis. We were qulified for more money, but targeted this price so that we can still maintain the house payments should something bad ever happen.

I sunk as little cash as possible into the house. I would rather keep the extra funds available for a TRUE investment.

 

[Runum]

I financed my house six months ago at about 190k with 3.5 % down and interest rate at 4.25 . It was a no brainer for me. Im not going to use my residence as an investment, but rather as a place to live. My family was renting a two bed 1200 sq ft apartment for the same price. We now live in a five bed 2900 sq ft house on a third of an acre. I dont have any regrets. Housing prices in the dallas area have fluctuated very little during the housing crisis. We were qulified for more money, but targeted this price so that we can still maintain the house payments should something bad ever happen.

I sunk as little cash as possible into the house. I would rather keep the extra funds available for a TRUE investment.

Yep, you can get a lot of house for little money in our neck of the woods.

 

[biggeemac]

Yeah....i moved here from the sf bay area a year ago. The real estate market sucks there. The folks here are a little diffent, but i dont have any regrets, other than missing family.

 

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[preciseau]

I financed my house six months ago at about 190k with 3.5 % down and interest rate at 4.25 . It was a no brainer for me. Im not going to use my residence as an investment, but rather as a place to live. My family was renting a two bed 1200 sq ft apartment for the same price. We now live in a five bed 2900 sq ft house on a third of an acre. I dont have any regrets. Housing prices in the dallas area have fluctuated very little during the housing crisis. We were qulified for more money, but targeted this price so that we can still maintain the house payments should something bad ever happen.

I sunk as little cash as possible into the house. I would rather keep the extra funds available for a TRUE investment.

If you don't mind me asking, are you investing the funds yourself (if so, what types of assets), or do you have someone else doing it?

 

[biophase]

Hello all - just wanted to play out a scenario with you.

If you had the cash to purchase your dream house (Ex. $1M) and still have money left over in the bank, would you do it, or get a loan? Granted, this is not a investment play - this is a house you would plan on living in or keeping in the family for a long time.

I think that you are in a different place than others. It also sounds like you understand exactly why cash would be good and why also taking out a mortgage would be good. For the purposes of this post, I am just assuming that you have $1.5M cash right now. Because if you had any less, I doubt you'd be asking whether or not you should pay cash for this home.

I am assuming that you have cashflow coming in that is proportional to your networth, meaning that you don't only have $1.5M and no cashflow or job. I also assume that you would have the cashflow to pay for a $1M mortgage, meaning you are not paying for it out of your $1.5M stash.

With the understanding that this is your DREAM home and not an investment, but a place that you can buy at $1M and just be happy to live in, I would go with all cash. Yes, your money sits there in a house that may or may not appreciate. But there is a nice feeling of having no payments on something.

There's nothing wrong with buying stuff outright. At some point in your life you have to stop leveraging as much and begin to preserve capital. If you purchase the home cash, and invest the remaining $500k, and your investments go bust, you still have a $1M asset.

Your alternative is to put down $300k and finance $700k with the understanding that you can make at least 3-5% on your $700k.
But if you have $1.5M, you are really asking if you should invest the full $1.2M and put down $300k. Else if you only invest $500k, the remaining $700k is sitting in the bank at .5% and you would be better off having paid cash.

Also, if you put down $300k and invest the $1.2M and they go bust, you could be in a position where you can't even afford your home. If you lose that to foreclosure you are back down to zero.

So I guess the answer to your question is how risky do you want to be with your nest egg.

 

[mohawkdcg]

Im not going to use my residence as an investment, but rather as a place to live.

Jealous of the low cost there! I agree, the home you live in should be viewed as a necessary expense, not an investment. For this reason I don't consider rent thrown away as I either pay a landlord or a bank/property tax unless buying outright. Here in California the high price of land adds an additional risk if you put most of your net worth into it. Large sections of the USA do not have this same risk.

 

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[biggeemac]

Exactly....had i bought a house in the bay area, that probably would have been my one and only investment. I know plenty of two degree families out there that need two large incomes just to keep the house payment afloat. Ridiculous.....and they tried to convince me that it was a smart investment.....doubly ridiculous. Decided i needed to leave the state for the good of my family.

 

[CTamme]

Another consideration is to put down enough money to avoid the interest rate bump for a Jumbo loan. From a quick google search anything above $417k is nonconforming and rates look like they are sitting at ~4% right now. It might not be a big deal but something to ocnsider in your analysis.

Housing costs in California still blow my mind after living in the midwest all my life.

 

[Steve37]

Opportunity cost is simply too high to justify paying cash. It's not that difficult to find double digit cash on cash returns right now.

 

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[preciseau]

Opportunity cost is simply too high to justify paying cash. It's not that difficult to find double digit cash on cash returns right now.

Really? I have had meetings with guys at AllianceBernstein and they wanted to tie up $700K, I had a meeting with US Trust (Bank of America's private banking sector) and they wanted $500K - I understand they have these minimums for a reason, but I can't imagine giving a company that much money, having to pay yearly fees and have no guarantee that they are going to make money.

I understand the concepts of OPM and using leverage to make higher rates of return (never used it before), but just look at historical charts. 5 year and 10 year rates of returns of funds and stocks are around 10%. I know that there is a risk in investing, but to make 1-2% a year for the past 10 years would have destroyed the plan of getting a loan.

At the same time, you could leverage the money and make an extra million due to financing purchases. It is tough.

 

[Kak]

At today's rates I would get a loan. Actually I wouldn't buy a house over 400k anyway. Even if you throw cash down and buy it outright you still have to rent the place from the government anyway. If we actually had property rights I would think differently.

To non-retired entrepreneurs, cash is king. Why tie up the cash when even a well invested portfolio could easily beat your interest rate you pay on your mortgage.

 

[Steve37]

Really? I have had meetings with guys at AllianceBernstein and they wanted to tie up $700K, I had a meeting with US Trust (Bank of America's private banking sector) and they wanted $500K - I understand they have these minimums for a reason, but I can't imagine giving a company that much money, having to pay yearly fees and have no guarantee that they are going to make money.

I understand the concepts of OPM and using leverage to make higher rates of return (never used it before), but just look at historical charts. 5 year and 10 year rates of returns of funds and stocks are around 10%. I know that there is a risk in investing, but to make 1-2% a year for the past 10 years would have destroyed the plan of getting a loan.

At the same time, you could leverage the money and make an extra million due to financing purchases. It is tough.

You need to look at investment opportunities outside of the financial markets. Spend some time learning about real estate investing and you shouldn't have much issue generating double digit cash on cash returns by becoming a landlord, a private lender, or even buying performing notes. The key is to educate yourself first and don't skimp on legal counsel when navigating more complex transactions.

I spent several years paying a wealth manager a % of my portfolio under his management every year for him to under perform the S&P. Ridiculous waste of money and a mistake I won't repeat. Do the private bankers you've interviewed have a history of outperforming the markets on a consistent basis?

My general investment rule is if it doesn't provide cash flow and doesn't have a reasonable exit strategy, I don't want it.

 

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[danoodle]

I have run some example numbers. Mortgage on a $1M house financed at around 3% for 30 years, you will end up paying over $2M in the long run. Why pay an extra million? Would a 30 year investment yield more than that?

This is incorrect, at $1,000,000 principal, 3% fixed, 30 year term, you would pay just over 1.5M total.

Principal borrowed: $1,000,000.00
Regular Payment amount: $4,216.04
Final Balloon Payment: $0.00
Interest-only payment: $2,500.00
*Total Repaid: $1,517,774.40
*Total Interest Paid: $517,774.40
Annual Payments: 12
Total Payments: 360 (30.00 years)
Annual interest rate: 3.00%
Periodic interest rate: 0.2500%
Debt Service Constant: 5.0592%
*Total interest paid as a
percentage of Principal: 51 .777%

I was in the unique situation of renting while owning several rental properties. The numbers just made sense with rent only being $275 month. My friend is putting every cent he can towards his mortgage, which will be paid off by the end of this year, which I disagree with since his interest rate is so low. He has a family and 3 kids and is the sole earner, however, so he says that not having a mortgage will be such a relief and he feels comfortable with doing it, even if it's not necessarily the ideal way.

Think of it like paying off credit cards. Dave Ramsay's debt snowball vs. the highest interest first. Mathematically, you should always pay the higher interest debts first, period. However, some people need the psychological "win" of paying off the smaller debts, or they would never pay them off.

You "should", mathematically, get a loan on the house, especially with interest rates being at record lows, lower than ever in recorded history. It depends on your risk tolerance, though. If you don't feel safe with whatever investment you go with, maybe paying for the house outright is better for you. Mathematically, you could probably achieve a higher rate of return than the rate on the loan, but it comes back to your comfort level and how proficient of an investor you are.

 

[biophase]

Actually, if we are talking about maximizing all your money and having it available for investing, the best choice would be to rent that $1m home if possible.

 

[PatrickP]

This is incorrect, at $1,000,000 principal, 3% fixed, 30 year term, you would pay just over 1.5M total.

Principal borrowed: $1,000,000.00
Regular Payment amount: $4,216.04
Final Balloon Payment: $0.00
Interest-only payment: $2,500.00
*Total Repaid: $1,517,774.40
*Total Interest Paid: $517,774.40
Annual Payments: 12
Total Payments: 360 (30.00 years)
Annual interest rate: 3.00%
Periodic interest rate: 0.2500%
Debt Service Constant: 5.0592%
*Total interest paid as a
percentage of Principal: 51 .777%

I was in the unique situation of renting while owning several rental properties. The numbers just made sense with rent only being $275 month. My friend is putting every cent he can towards his mortgage, which will be paid off by the end of this year, which I disagree with since his interest rate is so low. He has a family and 3 kids and is the sole earner, however, so he says that not having a mortgage will be such a relief and he feels comfortable with doing it, even if it's not necessarily the ideal way.

Think of it like paying off credit cards. Dave Ramsay's debt snowball vs. the highest interest first. Mathematically, you should always pay the higher interest debts first, period. However, some people need the psychological "win" of paying off the smaller debts, or they would never pay them off.

You "should", mathematically, get a loan on the house, especially with interest rates being at record lows, lower than ever in recorded history. It depends on your risk tolerance, though. If you don't feel safe with whatever investment you go with, maybe paying for the house outright is better for you. Mathematically, you could probably achieve a higher rate of return than the rate on the loan, but it comes back to your comfort level and how proficient of an investor you are.

GREAT analysis. You are right it is better for your friend NOT to pay off his mortg from a financial point of view.

I did the same as he is doing, even though I knew financially it didn't make sense but the sense of safety/comfort it was worth it.

Now I find out BOA is lowering mortg amounts even for people who are paying on time uggggg lol

 

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[mohawkdcg]

I was in the unique situation of renting while owning several rental properties.

danoodle, I did the same. Sold my residence in 2006 and moved into a rental. Then continued to buy rentals in a state where I could get a good cap rate.

 

[preciseau]

Actually, if we are talking about maximizing all your money and having it available for investing, the best choice would be to rent that $1m home if possible.

What about doing a lease to own option?

 

[Money mania]

Here is some quick numbers that compare paying cash vs mortgage for what it is worth.

Say you are in 30% tax bracket
$1,000,000 4% rate on mortgage

You could right off roughly 12k a year in interest (40k*.3) if you had a mortgage
If you paid cash for house with no mortgage you would save on paying out $40k a year in interest
At end of day you are saving 12k giving to government in taxes writeoff to pay 40k in interest to bank.
I do understand leverage your money, just thought I would throw this out there.

 

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[biophase]

What about doing a lease to own option?

You would only do this if it were in your favor. A savvy investor would craft the lease option to favor themselves. If you can go in for little or no option price, same rental rate (maybe get a nice monthly credit) and your option purchase price were set at $1m, it could be the way to go. However, if you do a L/O you may be responsible for repairs. I personally would just rent and if you like the home in 6 months, approach the owner about an offer. You may get a lower price because he would be FSBO at this point and save 6%.

Look at it this way. A $1m home would probably not cashflow with 20% down if you were the investor. Therefore, your rent would be lower than your PITI, plus you don't have to worry about appliances and things in the home breaking.

The downside to renting is that you don't get the tax break and if the home appreciates you miss out on that.

The upside is that you are in your home for a monthly payment of less than your mortgage would have been. You also did not have to put any money down. You don't have to pay for any home repairs.

If the housing industry remains the same in 2 years, you are actually in a better position to buy.
If it goes down, you'll be happy you rented.
If it goes up, you may miss out on it, but the overlying assumption here is that all the money you saved by not buying a house is being invested in something that returns more than 3-5%.

 

[PatrickP]

Here is some quick numbers that compare paying cash vs mortgage for what it is worth.

Say you are in 30% tax bracket
$1,000,000 4% rate on mortgage

You could right off roughly 12k a year in interest (40k*.3) if you had a mortgage
If you paid cash for house with no mortgage you would save on paying out $40k a year in interest
At end of day you are saving 12k giving to government in taxes writeoff to pay 40k in interest to bank.
I do understand leverage your money, just thought I would throw this out there.

12K the first year. What about by the 15th or 20th year?

 

[Luke12321]

I just purchased my first home (at 27) for all cash.

For me, I could of got financing but I have never built up a ton of credit history so I couldn't of got the best rate possible. Also, just from my experiences working in debt collections....I have witnessed many people be leveraged when income is good, things go south and they end up with nothing. Personally, I like knowing that even if shit hits the fan...I won't be losing my house. I also enjoy the fact that unlike my friends who are making a mortgage payment every month, I can take weeks/months off without working and can afford it. I am not tied to having to produce income each month (even though I do) in order to have a house.

Another reason I decided to pay all cash is because currently I am single. At my current point in live, I am not in a position to where I feel that I can invest in something to the point that it would make more financial sense to rent. I don't want to be 100% liquid situation and buy a house after getting married when mine is hers and and she leaves with half of mine. lol

I guess it is all about what you are comfortable with, what makes you happy, and what fits your long term goals!

 

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