Picking between Paying Cash and a Mortgage

On Monday I posted a piece titled "Should You Pay Down Your Mortgage" and thought I'd end the week with a similar piece. This one has a twist. It's not about paying off a mortgage early, but about paying cash for the house up-front. Here's the question posed to Yahoo:

We are selling our home in California and moving to Arizona. Should we pay cash for the new home, or get a loan for around $150,000 and invest the remainder? I would invest in secure products. Not the stock market. We will probably make around $50,000 this year. Is the mortgage deduction worth it for us? We really would have no other big deductions.

Here's their answer:

I don't know enough about the mortgage interest expense on your current home to say whether you would benefit from itemizing in the 2005 tax year. So it's the incremental amount over the standard deduction that gives you additional tax savings. If you don't have any other big deductions, then it's going to be a pretty small incremental tax savings. Talk to your tax adviser if you can't determine whether there would be an advantage to itemizing.

Your financial goals will also influence whether a mortgage is right for you. If you are approaching retirement and don't want to have a mortgage in retirement, then paying cash for the new house can make sense.

If you're worried about preserving your financial flexibility, then taking out a home equity line of credit, or HELOC, allows you to tap your new home's equity for financial emergencies.

Taking out a mortgage so you can invest cash elsewhere only makes sense if you can expect to earn more after tax on your investments than you pay after tax on your mortgage. If you aren't using the mortgage interest deduction on your taxes then the interest rate on your mortgage is your bogey in determining whether you should invest in something other than your personal residence. Assuming roughly a 6 percent interest rate on a fixed rate mortgage, there's not many safe investments expected to outperform that rate in the current economic environment.

Translation: Pay cash for the house. (Why to these money guys always have to prattle on?) FYI, it's the move I would make personally as well.

Comments

[mbhunter]

Unless they can get a much better return than they're paying out for the mortgage, they should pay cash.

They have the luxury of paying cash. They don't need approval for jack! If they finance it they have to pay a lot of lender's fees -- appraisal, underwriting, origination possibly, etc.

[David Porter]

I don't believe we know enough about this couple to make a recommendation.

Are they retiring? If so, no mortgage. Perhaps a reverse mortgage however.

Let's assume they are 35 years old. Then by all means get a mortgage. In Arizona the bottom of the market is around $250,000. Why tie up that much cash for 30 years. That cash could go a very long ways to their retirement put elsewhere for that period of time.

[Tom Devine]

I am in a similar situation. One of the areas often overlooked when considering this question is what flexibility having no mortgage payment can give in other purchases. For example, having no mortgage allows a person to actually 'save' for a new auto purchase rather than financing thus saving interest expense. It's not easy to save $35k when you're making house payments.

The same goes for other debt. We have to be realistic about American spending habits - I wish I could say 'savings habits' there but I can't - and realize that the average Joe is leveraged to the hilt.

Just my two cents.

[I need advice on buying a house from a friend with cash from an estate settlement.]

I have been renting a house, from a friend, for six months. He has asked me if I want to buy the house and has offered me a very good price. (approx. $10-15K below comps in the area) Can I just hand him the money and him sign over the title like a car? I plan to make sure the title is clear before I do anything else, of course! Should I hire a real estate lawyer?

[FMF]

I'll post your questions on the main page in the next week or so. Stay tuned.