As I mentioned last week, we may have an opportunity to do something that most people can’t afford to – Pay for a house in cash. If we sell our 2 rental properties and our primary home, then we should have enough for a bigger house (about 1,500 sq ft in a really good location). However, is it a good idea to pay cash for a house? The interest rate is still very low, so shouldn’t we take advantage of it?
I like mortgages and I don’t think they are bad debts as long as you don’t overbuy. In fact, I wrote a long article detailing why I didn’t want to pay off my mortgages last year – Should you pay off your mortgage if you could? However, I’m starting to change my mind. So today, I’ll try to see it from the other point of view. Let’s go over some reasons to pay cash instead of getting a mortgage.
1. No More Debt
The last time I didn’t have any debt was in 2000. That was before we purchased our first home which is currently being rented out. It would feel great to have absolutely no debt at all again. Mrs. RB40 would feel more secure about life and it would lessen her stress level a bit. She seems to be more stressed out lately.
2. Lower monthly expense
Currently, we are spending about $2,200/month on housing and that’s pretty high. If we pay cash for a house, then our monthly expense would drop quite a bit. I think we can probably keep it under $750 for housing if we don’t have to send the monthly mortgage payments to the bank.
Our total monthly expense would reduce to about $2,000/month. Our passive income and my online income are enough to cover that kind of monthly expense. Mrs. RB40 would have the option to retire sooner if she’d like. She enjoys working though, so I doubt she’ll quit anytime soon.
3. Difficult to get a loan
I’m not sure how much money the bank would let us borrow at this point. I don’t have a W2 anymore and I heard that it’s much harder to get a loan now. Mrs. RB40 still has her job and we can probably get a smaller loan. We’ll have to drop by the bank to see what they have to say.
I don’t think banks give much credit to self employment income. Quicken Loans called me up to sell a refinance and couldn’t hang up fast enough when I told them I’m self employed now. They want you to be self employed for more than 2 years before they even consider that income. That was my impression anyway.
4. Financial security
Having no mortgage would mean financial security for my family. If I pass away, then they would be able to carry on without too much financial trouble. We won’t have my online income anymore, but the life insurance payout should replace most of that. Mrs. RB40 can invest the proceeds in our dividend portfolio and the dividend should be enough to pay the monthly expenses. Mrs. RB40 can stop working for a while if she needs to.
5. Stock market is at an all time high
If we get a mortgage, then we’d have a bunch of cash left over from the rental sale. I will most likely invest that in the stock market which is at an all time high. The market is probably due for a sizable correction within the next few years, but what do I know? Adding a large lump sum right now seems a bit risky. We are still contributing to our 401k every month and that’s fine because we are dollar averaging in a small amount at a time. In the long run, dollar cost averaging works pretty well.
6. Leverage opportunity still possible
We’d have the ability to get a home equity line of credit (HELOC) if an opportunity comes up. Let’s say the stock market drops by 30%, then I’d feel fine about borrowing some money to invest.
7. ROI guaranteed at 4.5%
We can get a 30 year mortgage at about 4.5%. That’s 4.5% guaranteed return if we pay cash. Sure, the stock market probably will do better in the long run, but it’s not guaranteed. 4.5% is actually pretty cheap as far as borrowed money goes.
8. Tax deduction not that useful at our income level
I haven’t done taxes yet this year, but I think we are at the upper end of the 15% tax bracket in 2013. When I was an engineer, we were in the 28% tax bracket and the mortgage interest deduction was quite useful. Now that we are in the lower bracket, it doesn’t seem as advantageous. If we borrow $400,000 at 4.5%, then we’ll pay nearly $18,000 of interest in that first year. We’d be able to get about $2,700 in tax deduction, but that still means we’ll lose about $15,000. That’s a lot of money and if we can avoid it, why not?
This is just an estimate. I’m not a tax expert, so the number is probably off somewhat.
9. Attractive to seller
If we come to the table with cash, the seller would give us more consideration. The closing can be done much quicker because we won’t have to wait for the bank to approve the loan. Sometime a buyer makes an offer, but the bank doesn’t approve the loan and the home owner has to start the selling process all over again. I’d be willing to give the buyer a little discount if they can close quickly in this market.
10. The 1031 exchange possibility
This one is pretty complicated and we probably won’t be able to make it work, but it is a possibility. We’d need to sell our 2 rental properties within a relatively short time period. Then we’d need to find a property that we’d like to live in within 45 days. This property needs to be about the same value as our current property and we’d need to get a similar sized mortgage. The bank needs to approve the mortgage and we’d need to close within 6 months. Then we’d need to rent it out for a few years. Then we’d need to move in and live there for at least 5 years. Then we can sell it and avoid the capital gain tax…
Whew, that’s a lot of things that needs to get done in sequence within certain time frames. I’m not an expert, so I’ll need to hire a tax advisor and a 1031 exchange intermediary. Anyway, I’m pretty sure we can’t get that kind of mortgage anymore, so this is an extremely long shot. Probably not worth stressing over.
I’m still undecided even after writing this article. The market is pretty hot in Portland and we’ll definitely sell our 2 rentals this year. We probably have to wait a year or two for our condo’s value to improve a bit. It hasn’t recovered from the housing bubble yet because there were a lot of short sales and foreclosures in our building. Who knows what the housing market will look like in a few years. There might be some good deals again. At that point, we’ll decide if paying cash is the way to go. Meanwhile, I’ll probably invest the proceeds in our dividend portfolio unless you have a better suggestion.
Would you pay cash for a house if you could? If you’d rather get a mortgage instead, where would you invest the lump sum?
photo credit: flickr amagill and RMLS