Should I Pay Cash or Get a Mortgage?
Now that we’ve seen the real estate market bounce back and show real signs of stability, one common question our clients ask is whether they should pay cash when purchasing a home or take out a mortgage. Knowing the specifics of each client’s financial situation, it’s easy to determine which option makes the most sense for them, but speaking in general terms, which makes more sense financially?
There are a variety of factors you should keep in mind if you’re buying a home and trying to decide if you should pay cash. First, consider your personal financial situation such as how much cash you have sitting on hand. You should have enough emergency cash to cover at least 6 months worth of living expenses. If paying cash brings you below this point, it’s probably wise to more seriously consider a mortgage.
You should also think about your liquidity, risk tolerance and whether there are any personal factors that prevent you from wanting to carry a monthly payment or any additional debt. Despite the numbers, some people just don’t want to carry the debt or spend extra money on interest payments. This is a personal choice, and an important one, because you should always feel comfortable with how you decide to invest your money. If you’re really not sure which approach is best for you, consider talking with a financial professional who can provide advice that’s specific to you.
It’s also helpful to consider the benefits of each. In general, we believe that securing a mortgage is the better option. Here’s why:
1) Rate of Return. For most people, there are two options – either invest cash in a home or take out a mortgage and invest the cash in the stock market. By paying cash, your money is tied to a single asset which typically has a lower rate of return than the stock market. When looking at the historic annual rate of return for the stock market, you can clearly see that you’re likely to come out ahead by investing the cash. Simply looking at rate of return leads most to the conclusion they do not want to pay cash. However, it’s important to understand your risk tolerance for investments. For investors who are risk averse and unlikely to invest in equities, the math becomes less convincing.
2) Liquidity. Even though you’ve already identified how much liquidity you would have if you were to tie up cash in a home, it’s important to talk about the benefits of liquidity. I’m a strong believer in liquidity because you never know what tomorrow will bring. If you find yourself in a position that you suddenly need cash, and it’s tied into your home, you may have to look at options that are less than ideal like selling or equity loans. By keeping your cash in liquid investments, you give yourself more options for covering unexpected expenses.
3) Tax Benefits. One of the clear benefits of having a mortgage is that you can write off your interest payments and use them as tax deductions. For those who are wary of their tax rate and are usually looking for write-offs, mortgaging a home purchase makes a lot of sense.
While this probably doesn’t answer the question for you specifically, hopefully it’s given you some things to think about to help decide. If you want to talk specifics, give us a call. Otherwise, our general point of view on the subject is this: If you have a long time horizon and investing in stocks is within your risk tolerance, it makes sense to go the mortgage route.