Consider The Pros & Cons of Paying Cash For Your Home
Mike Milligan has the types of money problems most of us would probably envy: He’s not sure if he should pay for his new home all in cash or not. Seriously – what a dilemma!
These Sacramento Baby Boomers Are Cashing In
The Sacramento area, native and his wife have been frugal with their money. They’ve saved and invested well and now have more than enough money to live comfortably in their retirement. The couple found the retirement home of their dreams and are ready to pull the trigger. Yet still, is the lingering problem Mike faces – wondering whether it’s a good idea to pay cash for his home and forgo the headache of a mortgage. It might be easier to just cut the builders a check.
My brain says “Be logical. You’d probably be able to get a better return on that money if you invest it instead, but my heart says no mortgage is a good mortgage.” Mike says.
Paying cash for your home might be considered the smart choice if you can afford it, particularly when heading into retirement – when your best earning years are behind you. Still, there are a number of factors to consider before tying up such a large lump sum into one large investment.
The primary draw of paying cash for your home is obvious to anyone: security. There’s no monthly mortgage payment hanging over your head should your financial forecast get a bit cloudy.
Cash on the barrel – that methodology usually creates a seamless transaction in every walk of life and paying cash for your home might make as much sense when you think about it. Sellers may be more inclined to lower the price of the home for buyers who don’t have to jump through any of the lenders’ hoops in order to meet eligibility requirements for them to get a loan. Paying in cash also cuts down on administrative fees and paperwork involved at the close of the new home.
So Far Everything Has Been Upside… What’s The Downside To Paying Cash for My Home?
There are drawbacks to paying for a house in full, though, the most important of which is liquidity or the lack of it. The quest to become debt-free can sometimes result in making choices that may impede future financial growth – it’s an important question to consider.
Spending $500,000 cash on a home is great if you’re a millionaire and can easily afford it. Maybe not so smart if it’s the majority of your savings. If you need to get your hands on cash quickly to cover something unexpected — sudden illness, a family member in dire financial straits, legal entanglements or even god forbid – a natural disaster — you can only get your money of your home by selling or borrowing against the property.
Retirees in particular can find it difficult to obtain a second mortgage, or even a home-equity loan, because they’ve since lost that steady source of steady income they had when they were younger.
Homeowners who do decide to pay cash for their homes should immediately open a home-equity line of credit to ensure money is there and available to them when they need it. In desperate straits, you also have the option of obtaining a reverse mortgage — a loan that lets homeowners convert part of the equity in their homes into tax-free income without having to sell the house or give up title to it. The loan is repaid when the borrower sells the home or dies.
Apart from liquidity, consider which option will give you the most bang for your buck. “I ask my clients, ‘What’s the mortgage rate?’ Paying in full for a house is similar to investing in a bond that pays the same interest rate you’d pay with a mortgage,” says Carlos Montoya. So opting not to pay a 30-year mortgage with a 6.5% interest rate is equivalent to earning 6.5%. And depending on your financial situation, that money could be earning that much — and possibly more — sitting in a relatively safe, tax-advantaged investment such as a municipal bond.
And speaking of taxes, I know what you’re thinking: What about the tax deduction? It’s a big benefit, yes, but unfortunately not nearly as big as you think. Many people believe mortgage interest payments cut your taxes dollar-for-dollar, but that’s not the case. Assuming your annual income in retirement falls within the 27% tax bracket ($27,051 to $65,550 a year for singles, $45,201 to $109,250 for marrieds filing jointly in 2001), you’re reducing your tax bill by just 27 cents for every $1 you spend in interest.
Another Great Question I Get Asked All The Time
Should I pay off my mortgage using my 401k?
Do The Math, How Much House Can You Afford?
To help you figure out how big a benefit taking out a mortgage may mean for you, mortgage-information Web site Mortgage101.com offers a tax-deduction calculator that can help you quantify the tax benefits of buying a home – we also have our own mortgage calculator on this website as well.
Another big misconception about buying a home in cash deals with estate-planning. Carlos Montoya, says people often will buy a home with cash and then later add a child’s name to the deed, believing that when the parent dies the home will transfer to the child tax-free. Think again, he says: “If you bought the house, paid cash for it, then put your child’s name on it, you’ll be subject to gift tax.”