Summary: In this article, you will learn the difference between buying a house in cash vs mortgage. Topics include, the pros and cons of paying cash vs getting a mortgage, buying a rental property with cash vs mortgage, and getting the best mortgage for your goals.
Many finance experts are saying to always avoid debt. Naturally, that causes us to think that putting as much cash toward a property as possible or buying it outright is our best option.
According to Zillow’s 2018 Consumer Housing Trends Report, just 23 percent of homebuyers in the U.S. pay cash for their homes.
There are so many considerations when deciding between buying a house in cash vs getting a mortgage. In this article, we will break down the pros and cons of each and help you determine the best strategy for you.
Pros and Cons of Buying a House in Cash
Next, we will discuss the pros and cons of buying a house in cash. Just because you can buy a home in cash, doesn’t necessarily mean you should. However, for some, it may be the right buying strategy. First, let’s dive into the pros of buying a house in cash.
7 Pros of Buying a House in Cash
Pro #1- No Interest
When you buy a home in cash, you don’t have to worry about interest accruing from taking out a mortgage. The cost of interest on a 30-year loan will likely end up costing you tens of thousands of dollars. Especially if you use the full 30 years to pay off the loan. Even with today’s low interest rates, a 30-year mortgage loan of $100,000 at 4% will cost over $70,000 in interest.
Pro #2- No Closing Costs
Because you are paying in cash, you can avoid paying closing costs associated with mortgage loans. You will pay no mortgage origination fees, appraisal fees or other lender fees. Although, it’s always a good idea to get an appraisal on any property you are buying to ensure you’re not overpaying.
Pro #3- More Attractive to Sellers
Private sellers usually prefer cash offers. In some cases, sellers will accept a lower cash offer than an offer from a buyer having to take out a loan. Paying in cash also reduces the risk of a buyer getting denied financing or the loan falling through for any number of reasons. This is often referred to as a cash discount for buyers.
Pro #4- You Can Usually Close Faster
If you’ve ever tried getting a mortgage, you know it can be quite the hassle. Getting a mortgage requires you to provide documents like, proof of income, bank statements, credit reports, debt-to-income-ratio, etc. When you pay in cash, you skip the entire mortgage process and can usually expedite the closing process and close the deal faster.
Pro #5- You Own the House Outright
Because your house is not leveraged against a mortgage, it’s easier to sell. Even if you have to sell it at a loss, if you own the property outright, it becomes much easier to sell, regardless of market conditions.
Pro #6- Your Credit Score Doesn’t Matter
Credit score is a big indicator for lenders to consider when accepting or denying a loan. If your credit score isn’t as high as it needs to be, paying cash will eliminate any need for a credit check because you aren’t taking out a loan. You don’t have to prove that you will be able to keep up with mortgage payments.
Pro #7- No Necessary Income Required
When borrowing a certain amount of money, mortgage lenders require you to make a certain amount of income. This is a way to measure the level of risk associated with you and your ability to make mortgage payments. If you are paying cash, it doesn’t matter how much money you make because you won’t be paying a mortgage.
7 Cons of Buying a House in Cash
Con #1- You Tie Up a Lot of Money in One Asset
Putting over $100,000 on a single real estate investment can be risky. If you tie up a large amount of money in one asset, your investment portfolio becomes less diversified, thus, increasing your risk for losing money.
Con #2- You Decrease Your Liquidity
Unlike other types of investments, like stocks or bonds, real estate is an illiquid asset. Meaning, it’s not quick, easy, or free to sell. Pouring most of your money into a house diminishes access to liquid assets.
Con #3- You Give Up Leverage
Nobody likes to be in debt. However, being leveraged in real estate actually presents an upside to debt. Assuming your mortgage is locked in and if you are able to get a low interest rate, you may be able to make money by having a mortgage due to the effects of inflation. If you paid cash, you give up that leverage.
Con #4- You Miss Out on Tax Benefits
In most cases, you can deduct up to a certain amount of mortgage interest on your itemized taxes. This can potentially knock out a huge chunk of money paid on interest and put money back in your pocket. If you’re using cash, you miss out on some really great tax benefits.
Con #5- Mortgage Rates Are a Cheap Source of Financing
As far as types of loans go, mortgages are typically the cheapest source of financing. Mortgage loans come with low interest rates, especially compared to other types of loans.
Con #6- Your Return on Investment May Be Less Compared to Other Options
Just because you can buy a house in cash, doesn’t always mean you should. It’s important to determine if your money could be better used for other investments. Run the numbers on other investment options and decide if putting some of your money elsewhere could yield higher returns than a house.
Con #7- House Rich and Cash Poor
Buying a house in cash and leaving little money in savings after doing so isn’t the best position to be in. What if unexpected expenses or major repairs arise and you don’t have the money to pay for them? Draining your savings in order to buy a house in cash is risky and could come back to haunt you.
Pros and Cons of Getting a Mortgage
Now that we’ve covered the pros and cons of buying a house in cash, next we’ll go over buying a house with a mortgage. The majority of people either don’t have enough money to buy a house in cash outright, or simply choose not to. Getting a mortgage can have many advantages, however, the cons may outweigh the pros, depending on your individual financial situation.
6 Pros of Getting a Mortgage
Pro #1- Less Money Upfront
Getting mortgage financing only requires buyers to put a percentage of the loan amount down. That means you are tying up less money in one asset and leaving enough money in the bank to cover repairs or expenses now or down the road.
Pro #2- More Flexibility
With additional cash reserves, the homebuyer has more flexibility to put their money somewhere else, or still have a nice sized nest egg in the bank in case of emergencies or other opportunities. As mentioned above, you can invest invest your money elsewhere, make yourself more liquid than if you paid in cash and have more flexibility.
Pro #3- Tax Benefits
If homeowners itemize their tax deductions, they can typically deduct mortgage interest on the first $750,000 on first and second homes. This is especially helpful for retired people who no longer have many options to reduce taxable income (i.e. 401(k) contributions). Remember to keep in mind that tax laws can change at any time.
Pro #4- Mortgage Rates are Low Compared to Other Types of Loans
Traditional mortgage loans are the most common for homebuyers. However, there are circumstances where a buyer may select an adjustable rate mortgage or ARM. An adjustable rate mortgage is a mortgage that does not have a fixed interest rate. It’s typical for an ARM to have a fixed rate the first few years of the loan, then changes periodically. Homeowners choosing an adjustable rate mortgage are usually planning to live in the house for the initial fixed interest period. This would be the biggest advantage to using an ARM. Interest rates will likely change after the initial fixed period based on market conditions and fluctuations. This fluctuation makes it difficult for investors to estimate their budget and potential return on investment.
Pro #5- A Mortgage Can Improve Your Credit Score
This is assuming that you make your mortgage payments on time, every month.
Pro #6- Inflation Should Make Future Monthly Payments “Cheaper”
7 Cons of Getting a Mortgage
Con #1- Mortgage Interest
Whenever you borrow money, you can always expect to pay interest. After all, that’s how lenders and banks make their money. For example, total interest over 30 years on a $200,000 loan with interest at 4.5% is $165,000 – almost double what you paid for the home.
Con #2- You Have to Qualify For a Mortgage
Mortgages aren’t passed out like free candy like they used to be before the market crash of 2008. Banks and lenders have learned they can’t lend money to just anybody. As such, qualifying for a mortgage has become harder to do.
Con #3- You May Have to Pay Mortgage Insurance Premiums
Putting a small amount of money down on a property, usually less than 20 percent, comes with a price. A mortgage insurance premium will increase your monthly mortgage payment, depending on how much you put down. This is to protect lenders in the event you are unable to pay your mortgage.
Con #4- Debt
Most financial experts will say over and over again to stay out of debt. Getting a mortgage is the highest form of debt for most homeowners. It can also be difficult to wrap your head around signing up for 30 years of monthly payments.
Con #5- Complex Mortgage Process
The process of getting a mortgage can be lengthy, time-consuming and sometimes frustrating. Lenders ask for pretty much any financial document available. They require qualifiers like, credit score within a certain range, proof of income, money in the bank, and low debt-to-income ratio. If you fall short in any of these categories, chances are you won’t qualify for the loan.
Con #6- Lender Fees and Closing Costs
Working with a lender to get a mortgage comes with many extra fees and costs. Buyers should expect to pay mortgage origination fees, appraisal fees, lender fees, and closing costs. All of these costs add up to usually a few thousand dollars.
Con #7- You Don’t Actually Own Your Home
When you finance a home, your lender basically owns the property while you make payments to them. They will hold the property title until the loan is paid off in full. Although you will be building equity in the home over time, if you fail to meet your end of the deal, you have a risk of losing it to the bank or lender through foreclosure.
Can I Pay Cash and Get a Mortgage?
Most buyers put cash down and take out a mortgage. While it’s possible to only put 5 percent down on a conventional loan, 20 percent is recommended. This eliminates mortgage insurance and lowers your mortgage interest rate. A few more reasons to pay cash and get a mortgage:
- Equity investment
- You can pay off early, with no prepayment penalties
- You can always pull equity with a cash out refinance
Why Do Rich People Still Take Out Mortgage Loans?
This question is asked all the time. People with a lot of money still take out mortgages for a couple of reasons. 1) They know home loans are cheap, and 2) you can yield better returns relative to other investments.
“Paying cash for the full purchase price of a house is similar to investing in a bond that pays the same interest rate you’d pay with a mortgage,” says James Bregenzer, owner of Bregenzer Group LLC, a private equity and capital management company. “For example, opting to not pay a 30-year mortgage with a 5.5 percent interest rate is basically the same as getting a 5.5 percent return on the investment price,” explains Bregenzer.
Buying a Rental Property in Cash vs Mortgage
As we have already covered a lot of these pros and cons in the sections above, I’m going to highlight just the key pros and cons related to buying investment property with cash vs mortgage. Having said that, real estate investors should rarely go for paying all cash on a property, unless you have a huge amount of money laying around.
3 Pros of Buying a Rental Property with Cash
Pro #1- 100% equity in the property
Pro #2- Immediate cash flow from rent
Pro #3- Avoid mortgage process
2 Cons of Buying a Rental Property with Cash
Con #1- Miss out on tax benefits
You have to pay tax on all rental income (minus rental expenses), so you’ll be missing out on rental property tax reductions. With mortgage financing, you can deduct interest payments from your taxable rental income.
Con #2- Less diversification
Aka putting your money all in one place
3 Pros of Buying a Rental Property with Mortgage Financing
Pro #1- Higher return on investment potential
I delve into more detail on potential ROI with mortgage financing in the section below.
Pro #2- Leverage your investment
2 Cons of Buying a Rental Property with Mortgage Financing
Con #1- Risk of foreclosure
You could lose your home by defaulting on a loan.
Con #2- Vacancies
If you rely on tenants to pay your mortgage and have trouble filling your rental, you could face paying the mortgage yourself.
Getting the Best Mortgage for Your Goals
Choosing how to finance your investment property could determine how profitable your return may be. If you have the money to buy a property outright in cash, you can skip financing all together. But, using leverage can substantially increase your return.
Kathy Fettke, Co-Founder and Co-CEO at RealWealth, explains in her book, Retire Rich with Rentals, why financing may be the better route for investors. “Which scenario makes more sense and puts you in a better position 10 years from now? Tying up your capital with one $100,000 home? Or putting down 20% and owning five homes?”
Fettke goes onto say, “Returns tend to increase with leverage as well. A $100,000 property that rents for $1,000 per month will likely yield a 9-10% annual net return. If financed, that same property might yield an 18% return because the investor used less of his or her own money.”
Do the Math
You’ll probably make more money investing your money somewhere else than parking it in a house. The average rate of return on an S&P 500 index fund is around 7 percent. On a 30-year loan, the average is about 4 percent, according to Bankrate.com.
The value of your property may go up over time, but in order to get your investment back, you must sell the home. We all know that selling a house is a process and takes time. Whereas, selling a stock or other liquid assets gives investors quick access to their money.
“You’re usually better served having the mortgage, taking the tax deduction and earning money elsewhere. People often forget how much that tax deduction is worth,” says Larry Saffer, president and founder of Saffer Financial Group.
Deep breath everybody! Now that you have weighed the pros and cons of buying a house in cash vs mortgage, you should have a solid idea of your next steps. Whether that be moving forward with a cash offer on a home or looking into your financing options for an investment property. You’re on the right track to using and investing your money wisely and hopefully putting yourself in the best financial situation possible.
Fettke, Kathy. 2014. Retire Rich with Rentals.