Wondering what is the best route to buy a home - cash or mortgage? We discuss the benefits and disadvantage of both to help you choose
According to a Consumers' Report published by Zillow in 2018, statistics revealed that only 23% of investment property buyers in the United States pay cash while 77% buy houses on loan. Even if you have the cash, should you buy fully pay your investment property upfront or should you take a loan? There are two sides to both approaches. Let’s look at them in-depth to help you make the right decision.
Interest is the cost of borrowing money. It is calculated as a percentage of the purchase price. For example, if you get a 30-year loan of $200,000 on an investment property at an interest rate of 6%, you'll end up paying $1,199 per month, $431,676 in total, $231,676 as interest over the life of the loan. That's more than the cost price of the property. Therefore, when you buy an investment property in cash, you don't have to worry about paying interest when you acquire mortgage loans.
In competitive markets with multiple bids, an all-cash offer improves your odds of getting the property. Some sellers may even be willing to accept a slightly lower price for the benefit of immediate closing, instead of the standard 30-day period required for loans.
On the other end of the spectrum, some banks do not want to deal with loan lesser than certain amounts in low-cost markets. Therefore, cash is a better way to purchase houses.
Mortgage comes with its own fees including origination fees, appraisal fees, closing costs, etc. It can be anywhere from 2% to 5% of the purchase price. HomeKasa still recommends conducting a property inspection to ensure that you are not buying a troubled property.
In the example above, if the property price doubles over the life the loan, it has just about caught up with the amount you have paid in interest and mortgage. On the other hand, when you buy with cash, the appreciation adds to your pocketbook.
When you're buying a property with cash, your credit score is not a hindrance or determining factor. On the other hand, a credit score is necessary to secure mortgage loans. If your credit score is not as high as it should be, your access to mortgage loans could be denied or you could be asked to pay higher interest rates.
Since the property is yours, therefore if you are facing some financial tribulations, you can decide to sell off the property to sort the immediate needs. On the other hand, mortgaged property is not completely yours and the returns are limited to the balance after you pay the bank what you owe.
For a primary home, you don’t have to worry about paying monthly mortgage dues. You own the house free and clear. For an investment property, the rental income is all yours to keep after you pay taxes to Uncle Sam and cover your other expenses like HOA, property insurance, repairs, etc.
By purchasing a property with cash, your risks are increased. In some locations, a mortgage balance protects your house from creditors who need to get their money back from you.
A liquid asset can be readily converted to cash. The stock market is an example of a liquid asset. Real estate on the other hand is not a liquid asset that you can sell easily. So, if you need cash, you’ll likely have to get a home equity line of credit or sell the property. Selling the property may take some time and effort.
Unlike mortgage loans, there are no tax benefits attached when you are paying cash to acquire a property.
Depending on the location, house prices keep up with inflation and may even appreciate better. You’ve to compare this against the other investment options available to you and evaluate which one will yield better returns on your investments.
By purchasing one house with cash, you may be limiting yourself from buying more houses. Every house purchase needs a certain amount of down payment for loans.
When you're buying a property on a mortgage loan, you'll only be required to put down a certain percentage of money upfront. Hence, you only need a fraction of the cost price to start.
By putting down a part of the purchase price, you can still build equity in your house by paying off the mortgage. You leverage the money you have to get more.
The interest paid on mortgage loans is tax-deductible. That said, always check the latest government policies before making a decision.
The value of money changes with inflation. While the Tiffany building in New York cost $2.6 million in 1906, $2.6 million now only gets you a condo in New York. Your money is likely to be worth lesser than it is now in a few years. With the mortgage, you pay a fixed amount every month. In our $200K loan example above, the $1,199 per month you pay upfront is worth more than the $1,199 you pay towards the end of your 30-year loan term (more on this in the cons section).
The bank is aware of the value of money now and in the future. Yes, they get the concept of net present value and they want your money now! They charge you interest upfront – most of the $1,199 payment goes into paying interest to the bank and you pay very little towards building your equity. In the first month, you’ll pay $1000 in interest and $199 in principal. Because of this reason, it may or may not make sense to refinance your mortgage when the interest rate drops.
We have some tips on reducing the interest paid and shortening the life of your loan. See how each extra payment impacts your loan positively.
Taking money from a bank requires you to prove to them that you are capable of repaying the loan. Banks look at several metrics including credit score, debt to income ratio, assets owned, income statements, tax filings, among other things. The loan to value of the house also matters. In a highly competitive market, the purchase price sometimes shoots over the assessed market value, making it harder to secure a loan. Depending on your situation, you may qualify for a loan at a higher interest rate, may be asked to put a larger down payment, or may not qualify for the loan.
If you are unable to pay the loan back within the agreed timeframe, you may lose your property. Mortgage forbearance goes up when the economic times are tough, as is the case during the Covid-19 pandemic. During the 2007 recession, short sales and foreclosures were high. Foreclosure impacts your credit score and future ability to attain loans.
Everyone’s situation is different. Whether you buy a house with cash or loan depends on your financial situation and the local real estate market dynamics. We hope that this article sheds light on how to go about making your decision.
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