Should You Purchase a Home With Cash?

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If you had the luxury of choice, would you buy a home with a mortgage or with cash?

A growing number of buyers are paying with cash, as we have previously reported, but whether it’s out of necessity or motivated by a carefully considered strategy is hard to say.

Some cash buyers may have no choice, as it has become tougher to qualify for a mortgage in the past few years. Others may be the classic retirement downsizers, who have plenty of cash from selling expensive homes for buying cheaper ones. Of course, low home prices also make cash deals easier to swing.

On the other hand, though, for anyone who can qualify for a mortgage, this is a good time to get one. The average interest rate on a 30-year fixed rate mortgage is an enticing 5.157%, according to the BankingMyWay survey.

Offering cash could also help you get a better deal on a home, or beat out other buyers who need to secure loans to go through with the purchase. Many applicants fail to get loans, so nervous buyers and sellers alike are likely to be attracted to cash deals if they have the means.

The most important question confronting a buyer considering cash is liquidity. If you can afford to tie your money up in the home for the long term, a cash purchase will save you a lot of interest over the years. Use the BankingMyWay Mortgage Loan Calculator to see how much.

Despite the potential savings, a home is not a good place to stash cash if you may need it for ordinary expenses or emergencies, since it would require a new loan or home sale to free the money up. In today’s market, it may be pretty risky to buy a home you don’t plan to keep for at least five or six years, or long enough for appreciation to offset the buying and selling costs.

And if you’ll need to borrow against the property sometime in the future, you may face a much higher interest rate than you do today. If there’s a reasonable chance you’ll ever have to borrow against the property, it makes sense to do it now rather than later. Get a mortgage and set your cash aside as a reserve.

If liquidity is not a concern – meaning you can afford to tie money up in the house – then the key issue is investment return. By paying cash, you’d avoid interest charges at around 5%, which is like earning 5% in a guaranteed investment like a certificate of deposit. That’s not bad, considering that five-year CDs pay only about 1.6%. Of course, CDs and other fixed-income investments may become more generous over the next few years.

Note that it’s important to compare apples to apples. Since mortgage interest is tax deductible, a 5% mortgage payment really costs you only 3.75% on an after-tax basis, assuming a 25% tax bracket. By paying cash and avoiding interest payments, you’d really come out only 3.75% ahead.

You might earn considerably more in a riskier investment like stocks, but with much more risk than you’d face putting money into your house.

If mortgages were charging 8%, 9% or 10%, which is not very unusual by historical standards, paying cash might very well make sense. At today’s low rates the decision is more of a toss-up.

For many people, the balance is tipped by non-financial issues. Having the home paid for can take a big worry off your mind, and being free of mortgage payments will help you survive more easily if income drops.

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.

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