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 or a 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.
- A mortgage can provide tax benefits for some and means a buyer will likely have more cash in the bank to tap when needed.
- When considering whether cash or a mortgage makes the most sense, opt for the choice that gives you the bigger bang for your buck.
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 of Robert J. Semrad & Associates LLC, 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, Connecticut. 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'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.
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 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 use of the mortgage interest tax deduction entirely.
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.
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.
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.
Not having a mortgage could negate a homestead exemption if you find yourself seriously in debt in the future.
The Bottom Line
The best advice when considering whether cash or mortgage makes the most sense is to opt for the choice that gives you the bigger bang for your buck. Also, ask yourself which will provide a greater return on your investment.
"Paying cash for the full purchase price of a house is similar to investing in a bond that pays the same interest rate you'd pay with a mortgage," says James Bregenzer, owner of Bregenzer Group LLC, a private equity and capital management company in Indianapolis, Indiana. For example, opting to not pay a 30-year mortgage with a 5% interest rate is essentially the same as realizing a 5% return on the investment price.
If you decide to purchase a house with a loan, make sure you can easily afford the principal and interest payments each month. If you decide to go with cash, make sure you'll still have enough to cover ongoing costs like property taxes, homeowners insurance, homeowner association, and other fees each month.