With mortgage rates dipping to all-time lows in recent months, first-time homebuyers and investors are scrambling to find choice properties, helping boost the housing market after a decline that’s persisted since the 2008-2009 recession.
Low rates would seem to imply that offering a small down payment and taking advantage of a favorable loan is a smart course of action. At the same time, mortgage loan interest rates also correlate to the rates available on other types of investments. Five years ago, when a savings account at the bank might return 4 percent, a 3.5 percent mortgage rate would have been a no-brainer — you’ll come out on top by taking the loan.
In today’s market, however, a 3 percent annual return can be tough to find in a secure investment, meaning that the balance between cash and loan in real estate is still a delicate decision. This summer, although Facebook CEO Mark Zuckerberg was able to lock in a 1.05% 30-year rate on his $7 million Palo Alto home as a preferred borrower, the take home point is that he locked in a rate at all. With an estimated $14 billion to his name, he could have easily paid cash, but even with the ‘little things,’ he decided to keep his money liquid.
If you’re trying to decide how much to put down on your new pad, don’t overlook these important considerations:
How Secure is Your Future Income?
If you’re sitting on a pile of cash, either through savings or inheritance, it may be tempting to plunk it down and buy a home outright. After all, you won’t have to worry about a monthly mortgage payment, meaning that apart from property taxes, insurance, bills, and upkeep, you’ll be living ‘rent-free.’ That’s an appealing prospect, and you’ll avoid paying a lender tens or even hundreds of thousands of dollars over the 15 or 30 year course of a typical mortgage loan.
At the same time, if you can’t guarantee future income to cover raising and educating children, illnesses that arise, and other life changes, you won’t want to clear out your bank account on a house, leaving you without enough liquid assets to pay for everything else in your life.
How Important is Closing the Deal on this House?
If you’ve found a home that you absolutely have to have, more cash up front can help to close the deal. Mortgage lenders are more cautious than ever since the recession, peering deep into peoples’ financial history and evaluating details to the point of minutia. By offering cash upfront, you’ll have leverage that other buyers still finalizing a sizeable mortgage won’t have, making you a more favorable option to the seller.
What Are Your Potential Closing Costs?
If you have the wherewithal to pay cash for a home, you’ll avoid closing costs, fees, and prepayments that lenders often require. You also won’t need to set up an escrow account, a system most lenders require to assure that insurance costs and tax payments are set aside throughout the year (and invested by the lender for a return).
Are You Purchasing the Home as an Investment?
No matter where you live and how good a deal a home seems like, there’s a risk inherent in real estate. If you own a home outright, that risk is entirely yours. When the home’s value rises or drops, it’ll be your benefit or loss. With a mortgage, that risk is split between the owner and the bank, who in the early years of a loan will likely own the majority share of the property. By keeping your money liquid and letting the mortgage company assume some of the risk, you’ll leave yourself more leeway in case of a collapse in value.
Do You Count on a Tax Deduction From a Mortgage Payment?
The federal government allows homeowners to deduct the interest paid on a mortgage, a valuable tool for many people, come tax time. By paying cash for your home, your end-of-year payment to the IRS will likely be higher. At the same time, that savings could still be less than you’d enjoy by not paying mortgage interest in the first place.
How Much House Do You Want?
The more future income you can demonstrate, the bigger loan you’ll be able to get, and the cash you have on hand will allow for a down payment on a more expensive house. Although you might have the savings to pay cash for an $80,000 home, that money might be better spent as a $40,000 down payment on a $200,000 home you’ll enjoy living in that much more.
It’s also worth noting that most lenders require ‘mortgage insurance’ on any home purchase where the buyer puts down less than 20 percent. Although it’s still possible to put down 10 percent or less on a new home, saving the extra monthly cash on mortgage insurance can make a 20 percent down payment a reasonable goal, even if paying cash for the entire home outright is not a consideration.
Have you bought a house with cash (or put down a larger-than-usual down payment)? Would you recommend paying cash for as much of the total cost as possible, or keeping your money liquid and getting the maximum available loan?
Kenneth McCall is a managing partner for storage.com. He builds the systems that help customers find the best self storage units for their needs. Through Kenneth’s and his team’s work customers can find storage units in Port Charlotte and in other locations in Florida. In his spare time, Kenneth likes to water ski, hike and participate in other outdoor activities.