Should I Pay Cash?

I HAVE THE MONEY…SHOULD I PAY CASH?

 

cash-reserves1An all-cash purchase can be viewed as an investment. The investment is not the house, because you are buying the house, and will enjoy any appreciation in its value, whether you pay all cash or take out a mortgage. The investment in an all-cash transaction is the mortgage you avoid. It might better be called a “no-mortgage” investment.

The return of the investment is the interest rate you would otherwise have paid on the mortgage but now avoid. This return can be compared to that of other investments in terms of return, risk and liquidity. 
Alternatively, using someone else’s money (a mortgage) to buy an asset (like a house) is sometimes referred to as “leverage”. It can also be referred to as an “inflationary hedge”.

Let’s say you have $500,000 in investments earning 4%. You could cash in your investments and pay cash. Your return would then be the appreciation of the property less carrying costs for taxes, insurance, association fees, utilities, repairs and management.  If your net return is more than 4%, you made a better investment.

Now compare that scenario with the same purchase using a mortgage. Let’s say you use $100,000 of your own cash and a $400,000 mortgage to purchase the property.  Your investments are still earning 4% which about covers the cost of a mortgage at today’s great interest rates.  Let’s presume your net appreciation after all costs is 2% per year. Don’t forget to include the income taxes saved due to the mortgage interest deduction. That means in 5 years your $500,000 investment is worth $550,000.  You just made $50,000 on an out of pocket cash investment of $100,000.  That is a 50% return in 5 years or 10% per year.  That’s way better than the 4% you were getting.  A good accountant can sort everything out.  The point is to use leverage as a tool to enhance your investment.

In summary, a long term fixed mortgage can amplify your return on equity in the likely event the home appreciates in value, and it is also a great tool in an inflationary environment. Should you tie up cash in a house when you could invest that cash and get a better return especially with inflation on the horizon?

Other benefits include the forced savings and the tax benefits of having a mortgage.

With the probability of rising interest rates and soon…now is the time. Rates are historically still LOW!

Credit to Penny Hill, Everbank Senior lending Loan Officer, Sarasota, FL