"Cash is king," goes the old adage. However, does that philosophy ring true when buying a home? Here’s a look at some of the pros and cons.
Why All Cash Makes Sense
1. You’re a more attractive buyer. A seller who knows that you don’t plan to apply for a mortgage is likely to take you more seriously. The mortgage process can be time-consuming, and there’s always the possibility that an applicant will be turned down, the deal will fall through, and the seller will have to start all over again, notes Mari Adam, a certified financial planner in Boca Raton, Florida.
Being ready to pay cash not only gives you an edge with motivated sellers eager to close the deal; it also helps with sellers in real-estate markets where inventory is tight and bidders may be competing for their property.
2. You could find a better deal. Just as cash makes you a more appealing buyer, it also puts you in a better position to bargain. Even sellers who have never heard the phrase “time value of money” will understand intuitively that the sooner they receive their money, the sooner they can invest or make other use of it.
3. You don’t have to endure the hassle of securing a mortgage. Since the housing bubble and ensuing financial crisis of 2007-08, mortgage underwriters have tightened their standards for deciding who’s worthy of a loan. As a result, they are likely to request more documentation even from buyers with solid incomes and impeccable credit records. While that might be a prudent step on the part of the lending industry, it can mean more time and aggravation for mortgage applicants.
Other buyers have little choice but to pay cash.
“We’ve had buyers who couldn’t get a new mortgage because they already have an existing mortgage on another house up for sale,” Adam says. “Since they can’t get a new mortgage, they buy the new property with all cash. Once the old property sells, they may place a mortgage on the new property or perhaps decide to forgo the mortgage altogether to save on interest.”
4. You’ll never lose a night’s sleep over mortgage payments. Mortgages represent the largest single bill most people have to pay each month, as well as the biggest burden if income falls off due to job loss or some other misfortune.
Years ago, homeowners would sometimes celebrate their final payments with mortgage-burning parties. Today, however, the average homeowner is unlikely to stay in the same place long enough to pay off a typical 30-year mortgage or even a 15-year one. In addition, homeowners often refinance their mortgages when interest rates fall, which can extend their loan obligations further into the future.
If peace of mind is important to you, paying off your mortgage early or paying cash for your home in the first place can be a smart move. That’s especially true as you approach retirement. Though considerably more Americans of retirement age carry housing debt than they did 20 years ago, according to Federal Reserve data. Many financial planners see at least a psychological benefit in retiring debt-free.
“If someone is downsizing to a less-expensive house in retirement,” says Michael J. Garry, a certified financial planner in Newtown, Pa., “I generally advise them to use the equity in their current home and not get a mortgage on the new house.”
What You Lose
1. You’ll be tying up a lot of money in one asset class. If the cash required to buy a home outright represents most of your savings, you’ll be bucking one of the hallowed rules of personal finance: diversification. What’s more, in terms of return on investment, residential real estate has historically lagged well behind stocks, according to many studies. That’s why most financial planners will tell you to think of your home as a place to live rather than an investment.
2. You’ll lose the financial leverage a mortgage provides. When you buy an asset with borrowed money, your potential return is higher – assuming the asset increases in value.
For example, suppose you bought a $300,000 home that has since risen in value by $100,000 and is now worth $400,000. If you had paid cash for the home, your return would be 33% (a $100,000 gain on your $300,000). However, if you had put 20% down and borrowed the remaining 80%, your return would be 166% (a $100,000 gain on your $60,000 down payment). This oversimplified example ignores mortgage payments, tax deductions, and other factors, but that’s a general principle.
It’s worth noting that leverage works in the other direction, too. If your home declines in value, you can lose more, on a percentage basis, if you have a mortgage than if you had paid cash. That may not matter if you intend to stay in the home, but if you need to move, you could find yourself owing your lender more money than you can collect from the sale.
3. You’ll sacrifice liquidity. Liquidity refers to how quickly you can take your cash out of an investment if you ever need to. Most types of bank accounts are totally liquid, meaning that you can obtain cash almost instantly. Mutual funds and brokerage accounts can take a little longer, but not much. A home, however, can easily require months to sell.
You can, of course, borrow against the equity in your home, through a home equity loan, a home equity line of credit or a reverse mortgage. As Garry points out, however, all of these options have drawbacks, including fees and borrowing limits, so they aren’t to be entered into casually.
The Bottom Line
Paying all cash for a home can make sense for some people and in some real-estate markets, but make sure you consider the downsides as well.