Should I Pay Cash?
The Pros and Cons
Every year there is a percentage of people who buy a home with cash. When there is more competition in the market, this number goes up since there is a greater likelihood of a transaction going through to close with fewer obstacles (such as buyer no longer being able to qualify for the mortgage, appraisals, etc).
There are pros and cons to paying with cash:
- Seller may favor an all-cash offer more highly than one with a mortgage attached
- No interest is paid
- No mortgage-related closing costs
- Faster closing process
- Less risk if something happens to income stream (if a homeowner loses his or her job, they still have a place to live)
- When more cash is tied up in an asset such as a home, that means there is less cash available for other items and possibly different opportunities that could yield more than the interest that was paid (see example below).
- There is no interest tax deduction
For example, let’s say a home price is $500,000 and the buyer has a choice of putting $100,000 down and mortgaging the rest or paying $500,000 outright. What do these options look like mathematically assuming mortgage would be a 30-year fixed rate mortgage at 4%? We are assuming all closing costs are paid and there are no other fees. We are also assuming that the $400,000 could be earning interest in the stock market or other investment returning 5% per year.
|Interest paid on $400,000 mortgage||Assuming 5% earned on $400,000 if it were invested elsewhere|
In this case, after five years, if the buyer had paid cash, he or she would have avoided paying $76,370 in interest. That is nothing to sneeze at, but remember, that would have also most likely have been a tax deduction.
But what if that $400,000 wasn’t tied up in the home and was earning interest? In this scenario, at an average 5% return, the cash buyer would have missed out on earning $110,513 in interest. Of course, these are scenarios with no guarantee and we don’t know for sure what the future will bring.
It pays to do the math! I can help.