Cash vs. Mortgage: An Overview
Everywhere you turn, you hear how bad it is to carry debt. So naturally, it's logical to think that buying a home with cash—or sinking as much cash as possible into your home to avoid the massive debt associated with a mortgage—is the smartest choice for your financial health.
But there's a lot to consider when contemplating purchasing a home outright versus financing it. Here are some of the major differences between using cash and taking out a mortgage to buy a home.
- Paying cash for a home means you won't have to pay interest on a loan and any closing costs.
- Paying off your mortgage (or not having one in the first place) provides a significant emotional relief that shouldn't be discounted.
- Investing your cash in the stock market, especially in a tax-advantaged account, will leave you with a higher net worth than paying off your mortgage faster.
Should You Buy a Home With Cash Or a Mortgage?
Benefits of Cash
Paying cash for a home eliminates the need to pay interest on the loan and any closing costs. "There are no mortgage origination fees, appraisal fees, or other fees charged by lenders to assess buyers," says Robert Semrad, JD, senior partner and founder of DebtStoppers Bankruptcy Law Firm, headquartered in Chicago.
Paying with cash is usually more attractive to sellers, too. "In a competitive market, a seller is likely to take a cash offer over other offers because they don't have to worry about a buyer backing out due to financing being denied," says Peter Grabel, managing director, MLO Luxury Mortgage Corp. in Stamford, Conn. A cash home purchase also has the flexibility of closing faster (if desired) than one involving loans, which could be attractive to a seller.
These benefits to the seller shouldn't come without a price. "A cash buyer might be able to obtain the property for a lower price and receive a 'cash discount' of sorts," says Grabel. A cash buyer could also purchase a home for cash and then still choose to do a cash-out refinance later after they have already closed on the home purchase. This allows them to get the best of both worlds: an easier home-buying process in a hot housing market with multiple competing offers and the long-term financial benefits of taking out a low-interest mortgage while investing their money.
A cash buyer's home is not leveraged, which allows a homeowner to sell the house more easily—even at a loss—regardless of market conditions.
Is a Mortgage Better?
On the other hand, obtaining financing also has significant benefits. "Even if a buyer has the ability to pay cash for a home, it might make sense to not tie up a lot of cash to purchase real estate," says Grabel. Doing so could limit your options if other needs arise down the road. For example, if the home turns out to need major repairs or renovations, it may be tough to obtain a home equity loan or mortgage, as you don't know what your credit score will look like in the future, how much the home will then be worth, or other factors that determine approval for financing. While this is definitely something to keep in mind as a possibility, getting a home equity loan or home equity line of credit (HELOC) is easier the more equity you have in your home.
Selling a home bought with cash could also be a problem if the owners stretched a lot financially to buy it. "If cash buyers decide it’s time to sell, they need to make sure they will have sufficient cash reserves to put down as a deposit on the new home," says Grabel.
In short, "cash buyers need to be sure to leave themselves plenty of liquidity," says Grabel. By opting to go with a mortgage, you can give yourself more financial flexibility. Using a mortgage calculator is a good resource to budget some of the costs.
Paying a mortgage can also provide tax benefits for homeowners who itemize deductions versus taking the standard deduction. And while you shouldn't opt for a mortgage just to get a deduction, a reduced tax obligation never hurts.
"In most cases, mortgage interest payments are tax-deductible," says Semrad. The Tax Cuts and Jobs Act (TCJA) passed in 2017, however, nearly doubled standard deductions, making it unnecessary for many taxpayers to itemize, meaning they forgo the use of the mortgage interest tax deduction entirely.
Investing vs. a mortgage
Of course, with a mortgage, you end up paying more overall, since it comes with interest payments that do add up over time. But, depending on the state of the stock market, Semrad also notes that saving on mortgage interest by paying cash might not be financially prudent. You could be saving less than that money might have earned had you taken out a mortgage and invested the cash you didn't spend on your house.
The average annualized return of the S&P 500. Interest rates have averaged 2.96% to 4.54% over the last decade on a 30-year mortgage. While individual stocks and years can vary wildly, an investment over 30 years in a low-fee index fund would leave you with a much higher net worth than you would pay in interest on a mortgage of the same amount.
In addition to the stock market earning much more than you'll pay in interest, you may also save even more on your taxes than you would save with a mortgage interest deduction. If you use your extra cash to invest in the stock market directly or to live on while investing in a tax-advantaged account like a traditional IRA, Health Savings Account (HSA), 401(k), or other workplace plan, you will potentially save more in taxes than you would have by itemizing your mortgage interest.
In some instances, having a mortgage can protect you from certain creditors. Most states grant consumers a certain level of protection from creditors regarding their home. Some states, such as Florida, completely exempt the house from the reach of certain creditors.
Other states set limits ranging from as little as $5,000 to up to $550,000. "That means, regardless of the value of the house, creditors cannot force its sale to satisfy their claims," says Semrad. This is known as a homestead exemption, but keep in mind it does not prevent or stop a bank foreclosure if the homeowner defaults on their mortgage.
Here's how it works: If your home is worth $500,000 and the home's mortgage is $400,000, your homestead exemption could prevent the forced sale of your home in order to pay creditors the $100,000 of equity in your home, as long as your state’s homestead exemption is at least $100,000. If your state's exemption is less than $100,000, a bankruptcy trustee could still force the sale of your home to pay creditors with the home's equity in excess of the exemption.
Not having a mortgage could negate a homestead exemption if you find yourself seriously in debt in the future.
Having a mortgage won't completely protect your money, however. "If a homeowner left the funds in the bank and financed the house, a judgment creditor could lien the bank account and use the majority of the funds to satisfy its claims," says Semrad.
Can You Be Foreclosed on Without a Mortgage?
Paying off your mortgage doesn't mean your house can never be foreclosed on. You can still go into foreclosure through a tax lien. If you fail to pay your property, state, or federal taxes, you could lose your home through a tax lien.
Is It Easier To Buy a House With Cash?
Yes, buying a house is much easier with cash. You don't have to wait for an inspection, appraisal, or underwriting. Even though an inspection isn't required when you buy a home with cash, it is still a good idea to get one to make sure your new home won't come with any expensive surprise repairs. Home sellers will also usually favor cash buyers so they don't have to deal with lending timelines, which means your cash offer is more likely to be accepted.
If You Have Bad Credit, Do You Have To Buy in Cash?
No. Cash isn't your only option for buying a home if you have bad credit. You can still be approved for a mortgage through a Federal Housing Administration Loan with 10% down if your credit score is at least 500. You also may be able to improve your credit more quickly than you think to qualify for a conventional mortgage.
The Bottom Line
If you have a chunk of cash sitting around, mathematically you will end up with a higher net worth at the end of 30 years if you invest that money instead of using it to avoid getting a mortgage (assuming mortgage rates stay low and stock market gains follow the same average annualized return they have since 1929). However, not having a mortgage gives you a sense of freedom that is hard to replicate. If that feeling is worth enough money to you, then buy your house in cash.