If you’re able to pay cash for a property, an outright purchase has undeniable benefits. You don’t have to worry about your credit score or qualify for financing, and since many sellers prefer cash buyers, your offer might be chosen over another seller’s offer. But just because you’re able to purchase a home with cash doesn’t mean you should. Sometimes, a mortgage makes sense.
Whether you’ve received an inheritance, a settlement, or you’ve been an excellent saver over the years, here’s why you should consider buying a house with a mortgage, even when you don’t need to.
Several components make up your monthly mortgage payment, such as property taxes, homeowner’s insurance and private mortgage insurance (PMI). PMI is required if you have less than a 20% down payment. The monthly payment also includes repayment of principal and interest. This is the amount you agree to repay and the fee you pay for the privilege of borrowing money. Since a large portion of the monthly payment goes to paying down the interest in the early years of your loan term, your principal balance only decreases by a small amount every month.
The good news is that each year you can deduct the mortgage interest you pay on debts up to $1 million ($500,000 or less if married filing separately). This isn’t a dollar-for-dollar deduction like a tax credit. But this deduction can reduce your taxable income, resulting in a lower tax bill or a bigger tax refund.
Peace of mind and security comes with knowing you don’t owe a mortgage company. But you should never deplete your savings account to buy a house with cash. This is dangerous because you might face an emergency—such as a job loss or a medical crisis—before you’re able to replenish your cash reserve.
Of course, if an emergency occurs and you need access to cash after the purchase, there’s the option of getting a home equity loan or a cash-out refinance. You shouldn’t, however, view this as a backup plan. There are no guarantees that you’ll qualify for either loan. Approvals are based on your credit and income at the time of submitting the application. If you don’t meet the minimum requirements for financing, the bank will reject your application.
Instead of a full cash purchase, give the bank a large down payment and keep some of your assets liquid. For example, if you purchase a $200,000 house, you could put down $150,000 and then get a mortgage for the remaining $50,000.
Buying a house outright gives you instant equity, which is the value of your home minus what you owe the bank. Some homeowners think of equity as a savings, and they even use their equity to fund retirement. Although it contributes to a higher net worth, equity is unpredictable and based on your property value—which can increase, decrease or remain the same over the years. Even if you’re lucky and your home’s value holds or increases a little every year, there’s something to keep in mind: equity earns zero interest.
On the other hand, if you were to purchase a home with a mortgage, and then invest the cash you would have spent on an outright purchase, there’s an opportunity to increase your equity “and” your nest egg. So once your mortgage term concludes, you’ll have equity and a higher savings account balance.
Safe, low-risk investments such as certificate of deposits, money market accounts, bonds, treasury securities and high-yield savings accounts offer a guaranteed return. Other options include opening an individual retirement account (IRA), or allocating some of the money for riskier investments (stocks, house flipping, etc.).
Interested in learning more about your mortgage options or prequalifying for a home?
*Please consult a tax advisor for more information about any potential tax savings or deductibility of interest.