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10 Reasons To Pay For A House In Cash

by retirebyforty on March 3, 2014 · 81 comments

in investing, real estate, rental property

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10 reasons to pay for a house in cash

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.

Still Undecided

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

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{ 81 comments… read them below or add one }

moneystepper March 3, 2014 at 12:39 am

Because of number 7, I would probably never want to buy a house with cash. The money that you are giving up through leverage and the possibility of investing at higher returns elsewhere is just too great. Debt on your primary mortgage is usually the cheapest type of debt available (especially when you can obtain fixed rates over 15 or 30 years – 5 years is the max in UK) and therefore I would always try to take advantage of that.

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101 Centavos March 3, 2014 at 2:41 am

#9 is spot-on, Joe. We bought our acreage for cash a couple years ago, and the closing was quicker than a politician’s promise. And less paperwork, too.

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retirebyforty March 3, 2014 at 10:21 am

Nice. We don’t really want acreage at this point because we don’t have any time. Maybe a bit later.

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Income Surfer March 3, 2014 at 3:20 am

For a personal residence, yes I would be willing to pay cash. In fact we may pay off the balance in a couple years. It’s the only debt we have. In my state, your primary property can’t be taken away from you…..unless you don’t pay the mortgage or taxes. That seems like nice security because you need a place to live anyway. For our rentals, no I prefer the leverage.
-Bryan

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retirebyforty March 3, 2014 at 10:22 am

I prefer to leverage for the rentals also. It seems like a good time to get out. The cash flow is very small and I think people make money by the appreciation in our market.

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Retire Before Dad March 3, 2014 at 4:49 am

RB40,
To answer the original question, yes I would pay cash for a house. But for me it would only be if I had all the cash without touching my current investments, plus a good buffer. The feeling of having no debt and no mortgage would outweigh the precise math of it for me. But not everyone agrees with that. You will surely hear some strong opinions on this one. Getting a loan for a self employed person would be a challenge but its possible.
-RBD

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retirebyforty March 3, 2014 at 10:24 am

Yes, that’s the position we would be in once we sell our rentals. If we had to dip into our dividend portfolio, then we probably wouldn’t pay cash for a house. We also have some emergency saving already so that’s not a big concern.

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Holly@ClubThrifty March 3, 2014 at 5:45 am

We bought what is hopefully our “forever home” at the beginning of this year and they would not count any of my income since I am self-employed. Fortunately, we didn’t borrow a lot and Greg’s income alone was enough to secure our mortgage.

I would be thrilled not to have a mortgage at all. We were aggressively paying down our own home before we sold it, and now have to decide if we’re going to do the same in this home. However, we’re leaning toward not paying it off as fast and maxing out both of our retirements instead so that we can get under the income threshold for an Obamacare subsidy. If we don’t get a subsidy, our healthcare premiums are astronomical and we would still have a 10K deductible before anything was covered.

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SavvyFinancialLatina March 3, 2014 at 6:58 am

I would max out your retirement accounts first.

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retirebyforty March 3, 2014 at 10:30 am

We already maxed out our retirement account. This cash is from the rentals sale so it doesn’t impact any retirement or 529 saving.

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retirebyforty March 3, 2014 at 10:25 am

Yeap, that’s what I thought. If we get a mortgage, we probably won’t be paying down extra either. The rate is pretty low. Good job with Obamacare. It’s a good program for people who pay attention.

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Maverick March 3, 2014 at 5:49 am

We bought our first house from a relative at a resonable price with a small mortgage. Paid it off quickly, and haven’t looked back. Built house #2 with cash. Mortgage free (totally debt free) = priceless. Therefore, my vote is for you to pay in cash especially with today’s stock market levels.

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retirebyforty March 3, 2014 at 10:26 am

Thanks for your input. It’s great that you’re totally debt free. Hopefully, we’ll get there some day.

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mildred lane March 7, 2014 at 4:56 am

I use the pay cash for my home and for my rentals that I owner finance at 7 percent right now for 15 years. My idea is to let my investment in property pay for my retirement. I retired at age 56 and so far this has worked for me, now 75.
Another suggestion is once a year review your monthly bills and see if there is a way to lower -I just did this and was able to cut $50/month at AT&T, cut cable $30/month and using the free movie channels, using gas card to cut 10%/gallon of gas, changed my credit card to a “cash back” one,pay all bills by automation thru my cash back credit card earning money and saving on stamps,envelopes,time,I have been debt free for last 20 years.

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retirebyforty March 7, 2014 at 9:14 am

That’s great. There are many stories about real estate successes. It’s a long game, though. Not many people have the patience to deal with it. Our monthly bills are already low so there aren’t a lot of fat to cut.

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Violet March 3, 2014 at 6:17 am

Re #6
Buying when the stock market is low is historically a VERY bad idea, especially at 30% below average. When the market has dropped more than 8% in the past, it is very likely to keep dropping for an extended period. Buying low is basically saying that you are smarter than the market. Instead, buy high and sell higher is the best way to manage risk.

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retirebyforty March 3, 2014 at 10:27 am

I’m not convinced. Buying low seems like a much better idea in the long run. I kept buying when the stock market was crashing and it turned out pretty well. Lump sum investing might be different, though. Well, if we use that cash to pay for a house, then we won’t have to worry about investing a lump sum.

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living off dividends May 24, 2014 at 12:00 pm

Isn’t buying high selling higher also called the greater fool theory of investing?

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Paul March 3, 2014 at 6:47 am

Overall, good points to consider. Every situation is different.

1. Re #3: I’ve been self-employed since 2010 and combined with my wife’s income, we had no problem refinancing our house in 2012. We locked in at 2.79% on a 15 year note so we paid no premium for being self-employed. I would not state that you are penalized for being self-employed. If your bank gives you a hassle, simply shop around.

2. Re #5: To state that we’re at a high and that the markets will correct in the next few years is a given. We can also continue higher. Do not let the possibility of a decline influence your decision, because as long as there is a market, there will be market swings. If this worries you then you should not be in the stock market, because you will panic and withdraw your money once you’ve lost (on paper) a large amount, then will be scared to re-enter.

3. Re #5: Dollar cost averaging only works if the equity has a long-term trend upward. If it’s long-term trend is sideways or downward, you will lose money over the long haul. You probably know this so I’m stating the obvious but many do not.

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retirebyforty March 3, 2014 at 10:30 am

1. Thanks for that. I’ll shop around a bit.
2. I kept investing through ups and downs in the past. It’s just a bit different when you’re talking about putting $500,000 in at once.
3. You’re right. If the stock market trend downward in the long term then we’re all in trouble.

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Anon March 4, 2014 at 12:25 pm

I went through something similar a few years ago on my last home purchase (one w-2 income and one self employed income). Since the w-2 income was enough to afford the home, the bank disregarded the income from the self employed person.

As long as Mrs. RB40’s income is enough to carry the mortgage they lender probably won’t care you’re self employed.

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retirebyforty March 5, 2014 at 9:01 am

I don’t think her income is enough to qualify for a $400,000 mortgage. Perhaps we can borrow around $200,000.

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SavvyFinancialLatina March 3, 2014 at 7:00 am

We got a 15 yr mortgage for our first house. The difference between a 30 yr vs a 15 yr was only a couple hundred bucks a month, and we could pay it off in half the time. Our mortgage is small, the interest is not enough to be tax deductible. We are still better off with standard deductions.

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retirebyforty March 3, 2014 at 10:31 am

15 years FRM is great. I prefer that as well.

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John S @ Frugal Rules March 3, 2014 at 7:06 am

Generally speaking, I believe we’ pay all cash for a house. I think a lot of it would go back to us having no debt and more opportunity to do as we want. Being self-employed as well, it would make it much easier so we wouldn’t have to deal with the hassle of trying to secure a loan without the W-2.

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retirebyforty March 3, 2014 at 10:32 am

It will be a big hassle trying to get a loan without the W2. I’ll talk to a few banks and see how it goes.

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EscapeVelocity2020 March 3, 2014 at 8:11 am

Hands down, having a low interest rate loan for an extended period has historically been a win, and usually a tremendous win for the investor. But, like opportunity cost, you won’t ever see the money you didn’t invest, but 30 years from now, Buffet is betting pretty heavily that the markets will outperform anything ‘safe’ (I.e. he’s not selling his stocks to buy bonds). Don’t you wish you Could buy the s&p 500 at 1984 levels today? That’s the money a 40 year old is robbing from his 70 year old self…

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retirebyforty March 3, 2014 at 10:33 am

Sure, historically the stock market outperform the housing market. That’s how I felt previously, but I’m starting to change my mind. If I don’t need to take a risk, why take a risk? With a paid off house, we’d be secure and don’t need a win from the stock market.

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davidmichael March 3, 2014 at 8:16 am

Ok. Here’s my experience based on a major, bad decision regarding our retirement dream house and how we financed it just before we sold our business.

When we bought our first house in Eugene, we paid cash. Fortunately, my wife had enough investments at the time we could cash some out for the house. It allowed us to plow extra monies into our small company.

About ten years later when the kids were out of college, we found a dream property, so we decided to build our dream house of the finest materials money could buy in Oregon. We originally had plans for 1200 ft but we got sucked in by our architect’s drawings that zoomed it up to 2800 sq ft and a 900 sq ft detached garage. Totally, beyond our budget and real money assets. I don’t know what we were thinking. We went ahead with it and the foundation by itself cost $40,000. The problem was we could have paid cash for a 1200 sq ft craftsman house and not have a mortgage and be totally debt free.

Then, stressed out by the business after 20 years, I got cancer (Hodgkins Disease), and realized that the business was literally killing me with the day to day stress (age 56). I sold it a year later, was in good health again, and retired with just half of our retirement goals met (half a million instead of a million). And …we still had that damn mortgage ($200,000).

Long story short, we did enjoy the dream house for ten years, but the house eventually became a money pit, took most of our free time and money with three acres, and realized the house owned us not the other way around. Finally, we sold it. Man…what a feeling of peace and freedom when we retired once again to no debt. So…this is really not an investment decision in the big picture of things. This is about inner peace, quality of life, and freedom. IMHO, don’t get sucked in by the interest rates, investment deals, etc, etc. With age, stress free living becomes more important. That means, no debt! Time becomes more important than money. My advice…buy the house with cash. By time you are 50-60-70-80, you will thank yourself and your wife a zillion times over.

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retirebyforty March 3, 2014 at 10:35 am

Thanks for your input. We’ll avoid buying too much house. We’re just looking for a small house about 1,500 sq ft. But in a great area. That’s why the price is so high. Having no mortgage would be ideal.

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Mr. Utopia @ Personal Finance Utopia March 3, 2014 at 8:19 am

I most definitely, absolutely would purchase a house using 100% cash. You’ve listed lots of strong reasons why here Joe. For me, though, would be the sense of security it provides. You never know when you could lose your job, or if something happens and your online income dries up, or whatever else life may throw at you. Having no housing payments (except property taxes and repairs of course) would allow greater flexibility in cash flow if and when life throws a curve ball. You could also sell/relocate much easier/quicker to if you ever had to for whatever reason. I wouldn’t hesitate if I had the means.

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retirebyforty March 3, 2014 at 10:36 am

Thanks for your input. Mrs. RB40 would appreciate this. Security is big for her.

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SuperChief May 20, 2014 at 12:01 pm

I completely disagree. I would feel more secure having a mortgage along with my cash in a savings/investment account. Assume for example I had the choice of paying an additional $200k cash for a house. I would rather have a $200k mortgage along with a $200k savings/investment account. When faced with a crisis, I would have $200k liquid in order to make mortgage payments and get by for some time (probably a long time, i.e. 12-24 months at current lifestyle).

Had I paid cash for the house, I would have very limited liquid capital and fewer options. I would need to find a job ASAP or sell the house. Home equity is not liquid.

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retirebyforty May 21, 2014 at 10:00 am

That’s a great option too. Cash is king. I hate having cash in my account, though. If I had $200k in my saving account, I’d probably invest it somewhere. The most I’d keep liquid is probably around $40k.

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JP March 3, 2014 at 9:19 am

I doubt I ever beat the S&P500; paying off the house is tangible; market earnings are not. When you do the serious math, your gains, if you really get 8% annual, are not that impressive when compared with the risk.

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retirebyforty March 3, 2014 at 10:36 am

That’s what I was thinking. Why take the risk when I don’t have to? I’ll have to write another article on this topic. :)

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SuperChief May 20, 2014 at 12:04 pm

Is there not risk in home equity? I am pretty confident that historically, over pretty much any time period of 5+ years, equity markets have outperformed housing. It is not fair to consider stock market volatility and not housing market volatility!

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Financial Samurai March 3, 2014 at 9:25 am

I’d stay liquid and not pay cash. It all depends on how much money you have after paying for the house!

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retirebyforty March 3, 2014 at 10:37 am

Probably not much after paying for a house. Get a mortgage and keep the cash in the bank? I don’t know if I can do that. I don’t like cash sitting around earning 0.5%…

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Financial Samurai March 3, 2014 at 7:42 pm

I’d invest the difference elsewhere. There are so many things that can return greater than 4% IMO.

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Ravi March 3, 2014 at 9:27 am

I think risk/reward needs to be the primary consideration. You mentioned it above, paying cash is a guaranteed 4.5% return, but I think it’s higher, here’s why:

A 4.5% mortgage savings is serious cash, but it’s GUARANTEED. Even Treasury securities fluctuate in value, but this is a money in da bank 4.5%. Most people would be willing to pay a big premium for a guaranteed 4.5% return (maybe one day if CD’s get back up to their old rates). Plus, this 4.5% return is TAX FREE. If you took out the loan, you would be paying the mortgage with after-tax dollars. You mentioned your rate is 15%, but this is progressive, so including a conservative estimate of total tax effective rate ~20%, your return jumps to 5.625% (4.5% / (1-.80)).

THEN, you add the peace of mind of not having a mortgage, as well as the much improved monthly cash flow, and however you decide to spend/invest that, and you’re easily over 5.5% GUARANTEED return. I think people tend to focus only on the fact that you could invest and get a higher return. This is typically true, however, it’s all about risk/reward. Do you believe you are David Einhorn and can make 10%+ on risky bets year after year? Percentages make analysis very complicated. So let’s think of cash.

On a $200K mortgage, 30 yr, 4.5%, your total (gross) interest paid would be $164,813. Your choice. Personally, I have an investment property that is all equity now which generates ~$6.5K/yr net after all expenses. It’s probably worth now ~$140K, so could conservatively take a loan for 100K, but what’s the point? I rather enjoy my $600/mo in net cash earnings which I definitely use (indirectly) in many ways.

Great points above. I suppose it’s all about your risk tolerance.

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Ravi March 3, 2014 at 9:29 am

Typo, it’s ~$7K/yr net after all expenses.

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Pretired Nick March 3, 2014 at 9:30 am

I think you probably already know I agree with you. When I recently wrote about how to invest a large sum of money, most people came down on the side of dollar-cost-averaging vs. dumping it all in at once in a high market. In effect, by paying cash and investing all of your income, you will be doing just that. With great peace of mind on top of it all. I do agree that you should open as large a HELOC as they’ll let you have and stand ready to pounce if there is a big market crash.

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C. March 3, 2014 at 9:37 am

I feel you should call a couple of mortgage finance guys. You will then know what amount you would qualify for. I received a lot of current information from the guys that really knew their business. It would be useful to have that information and it is only a phone call.
Personally I would take a very small 15 yr. mortgage. If you ever needed money or equity loan in the future I believe this would make it easier to obtain. Banks & credit institutions want to loan money & being debt free seems to go against you, IMHO. It also would give you a payment history. It is very easy to get loan offers & o% interest rate offers when you have debt. We were deluged by offers whenever our debt went up. Also the mortgage would be small enough to pay off completely if you wanted to.
Due to personal experiences we have way more life insurance than we need. I like knowing if anything happened to either one of us there will be more than enough. . So I would also get coverage that pays off the mortgage in case of death.

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Cindy @ GrowingHerWorth March 3, 2014 at 9:45 am

I just had the cash house discussion with my boyfriend a few days ago. I ran the numbers, and given our incomes and lifestyle, once we started saving it would only take us about 5 years to have the cash to buy a house, maybe less. We each own a house right now, with very little equity in either, so we’d be looking at about a year to sell both and get things rolling.

I like the security of a paid off house more than anything else. He likes the idea of not having the mortgage, and being able to retire early and have money to spend (he has a fair sized pension). It’s looking like a very good plan.

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Steven March 3, 2014 at 10:39 am

I think there comes to a point where people want to simplify there lives and there finances. I think in the cash purchase it does exactly that. It simplifies your lives and your money. There is certainly tax and interest implications and always the age old argument of paying off your house vs investing in the stock market, but overall I prefer the K.I.S.S method if at all possible, good luck.

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retirebyforty March 3, 2014 at 10:02 pm

We need to simplify our finances. It’s just too complicated right now. We already have plenty invested in the stock market anyway. Thanks for your comment.

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C. the Romanian March 3, 2014 at 10:45 am

I would certainly go for paying for the house in cash because I consider all debt bad debt, actually. I am also self employed and I was recently shown how quickly your income can drop in this case: if we had a mortgage after I lost about 50% of my income, it would’ve been very difficult for us to pay it and live our daily lives. Nobody knows if the economy of the world will crash in 5 or 10 years or ever… but if it happens, it’s good to have your own house and not lose everything to banks and hyper inflation.

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retirebyforty March 3, 2014 at 10:04 pm

Right. At least when you own a house outright, you can live there without worrying. Actually hyperinflation is a good argument for having a mortgage. The payment would be stay the same, but it’d be actually much less in value.

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insourcelife March 3, 2014 at 10:58 am

I’ve been dropping lots of cash monthly over the last couple of year to pay off our mortgage soon, so yeh I’m 100% on board. I agree with all the reasons you listed and look at it this way: we used to carry 2 auto loans and it sucked. We paid off both many years ago and have been buying cars in cash since then. It’s such a great feeling to not have these payments hanging over our heads! Once our mortgage is paid off in a couple of years I plan on never carrying one again. If not having car loans is great, I know that not having a mortgage will feel 10 times better. It’s not all about simple arithmetic calculations (ROI, interest rates, etc) – there is real value in the feeling of financial security that being debt free provides. What’s the return on living a stress free life? How about the opportunity cost of a business venture you pass up because you “have a mortgage to pay every month” for the next 30 years?

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retirebyforty March 3, 2014 at 10:05 pm

Good comment about the car loans. We don’t have a car loan and it does feel great.

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Max March 3, 2014 at 11:29 am

Careful with 1031 exchange, you need to invest it in a rental property – yes you could do it the way you mention, but if you were to ever get a foreclosure than you wouldn’t be able to exclude the income from the sale of your home the way you normally would since you had previously rented it out.

It’s a bit tricky and if you mess it up you’ll need to pay back all the depreciation. Typically for rental properties it’s recommended that you hold on to them rather than sell them primarily to avoid having to pay back the depreciation which can greatly eat into the gains you may have from selling after closing costs and everything else factored in.

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retirebyforty March 3, 2014 at 10:06 pm

OK, thanks. I will need to talk to a tax advisor. I’m pretty sure we can’t make it work anyway. It’s too complicated with multiple properties and the mortgages.

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LRED March 3, 2014 at 12:04 pm

If you can get a rate below 5%, the mortgage should be an easy call if you based the decision off the math. The assets can be used to purchase a selection of mutual funds, ETFs, and individual stocks and bonds diversified between BDCs, REITs, foreign and domestic dividend stocks to kick off nearly enough income to cover the interest. You can also protect yourself from large market declines by purchasing market index puts to limit your downside risk relatively inexpensively. Note: all this assumes you are savy to distribute your assets between retirement and taxable accounts in an tax-efficient fashion.

I pursued this approach a few years back, locking in at 3.375% and increasing from a 15 to 30 year term. At the time I resisted pulling equity out and I regret that decision fully. Had I taken an extra 50K out in the refinance, my net worth would be nearly 25K higher. In running the math, the break point was around 6% where the security of the guaranteed return outweighed the reward of historically higher market rates of return. In the end, as long as you are disciplined and the assets (or equivalent values) are stashed in non-retirement accounts you have the option of paying cash whenever you choose, especially if you hedge the market with puts.

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retirebyforty March 3, 2014 at 10:08 pm

What if you already have plenty of investment in the stock market? Why risk it if you don’t have to? Now is probably a good time to hedge the market a little bit.

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LRED March 4, 2014 at 8:44 am

By paying cash with mortgage rates at their current levels you are assuming significant risk in lost opportunity cost. Essentially you lose any gains above the mortgage interest cost that money would make over the next 30 to 50 years. Are you 100% confident that you won’t outlive your money? What if Mrs. RB40 loses her job for an extended period of time? What if a family member experiences a major tragedy leading to significant health care costs for the rest of a lifetime? What if health care costs continue to increase well beyond inflation?

By paying in cash you are essentially saying, the market will produce less than 4% (30 year rate * .85 to account for tax deduction = 4.7%*0.85) annualized over the mortgage period. Keep in mind 4% is barely above inflation. Historically 6% is a safe rate of return to assume for a relatively conservative portfolio. Over a 30 year period at 6% annualized, the difference in paying cash for a $500K house versus investing that money is $400K. Over 50 year period at 6%, the lost investment opportunity cost is $800K. If you use more aggressive market return assumptions of 10%, the 30 year and 50 year lost opportunity costs are $2.4M and $8.7M, respectively. Even applying a FIRECalc style analysis, the 30 year costs range from $500K to $4.3M ($2M average), and 50 year costs range from $3M to $15.5M ($6.6M average).

In the end, a fully paid mortgage does not protect your home from debt collectors. If you don’t have the assests to pay taxes, medical bills, lawsuit decisions, etc your house is a viable asset that can be seized for those debts. So the question is, do you value the peace of mind no mortgage offers versus the increased flexibility having the initial $500K in savings provides and the reduced risk to outliving your money the increased assets, which will likely range from $500K to $10’s of millions, that investing that $500K for 30+ years provides? For me the lost opportunity cost is too great given the relatively low probability the market won’t return more than 4% annualized over a 30+ year period.

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retirebyforty March 5, 2014 at 8:59 am

Who can really confident 100% about not outliving their money? I am pretty confident right now. We are giving up some opportunities, but I don’t think it’s that much. We already have a lot invested in the stock market. If we don’t need to, why take on more risk. Anyway, we’ll free up some cash flow to invest in the market so I don’t think we really lose out on the whole thing.
Good point about taxes and medical bills. If the heath insurance expense is to high, then we’d probably move to another country until we qualify for medicare.
I will need to write an article with more analysis. Thank you for your comment.

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Bryce @ Save and Conquer March 3, 2014 at 12:08 pm

My wife and I were both very happy when we paid off our mortgage several years ago. We still have to pay property tax and insurance, but that is a fraction of what we were paying. Our cash flow is great. We have always maxed out our retirements savings, but now we also put what used to be the mortgage payment into taxable investments every month.

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retirebyforty March 3, 2014 at 10:09 pm

That’s one advantage of not having a mortgage that I forgot to mention. Having extra money left over at the end of the month is a great boost to your investment.

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Jason March 3, 2014 at 12:28 pm

#2 is a little misleading: your mortgage payment isn’t entirely an expense. The part that goes to interest is a debt service expense, but the part that goes to the principal is simply a transfer from a liquid asset (cash) to an illiquid asset (equity). If you have a strong preference for liquidity, then this is bad, but then if you have a strong preference for liquidity, you would want to keep all your money in cash anyway via an interest-first loan or something similar–or just rent!

Paying off the mortgage reduces your monthly expenditures, but it also reduces your monthly income–the opportunity cost is the flow of returns you would get from investing that money in the next-best alternative. In general, it seems likely to be the case that, for a low-enough mortgage interest rate, the benefits of a market return outweigh those of the housing market.

Moreover, the part that is an expenditure is a tax-deductible expenditure, and so you gain a significant advantage by living in a mortgaged home, at least as long as the mortgage-interest deduction stays in place.

Finally, a mortgage allows you to spread risk–if you own a home outright, you are exposed to all the downside risk. For a mortgaged house, you own the upside risk, but the downside risk is shared by the lender. In the event of a catastrophic loss, you can always walk away.

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Kemkem March 4, 2014 at 2:24 am

Very well put in my opinion. What’s to prevent you from putting down a good chunk of money, say 50 or 60%, take out a 15 year mortgage with a no penalty early payment clause, then paying down the mortgage aggressively if you want. You are still young, and tying a good chunk of your money in the house might not be a great thing. A lot can happen in the next 20,30,40 years of your life. The neighborhood could change, you could change etc..and you might not recoup all the money you put in. Taking out a HELOC does not guarantee that if the economy goes bad, the bank wouldn’t close it in a New York minute. Literarily, from one night to the morning, I got an email saying it had been closed. Think very carefully about this. It is very easy for us as armchair advisors, but this is your real money.

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retirebyforty March 5, 2014 at 8:50 am

That’s a good idea too. We don’t view a house as an investment. It’s a place to live in. You’re right about the HELOC. I haven’t needed it before and hopefully won’t in the future. I’ll keep this option in mind. Thank you.

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The Stoic March 3, 2014 at 3:11 pm

Wow… Lot of great comments here. A good post supplemented by great comments. Nice.

I vote pay cash. #1 #2 and #4 are the big ones. It’s nice not having a mortgage payment to make and although there a several arguments to make based on the math side of things, this is your home. It’s a place that you and your family will plant roots and create memories; what variable accounts for that in your equation?

Make a profit off your sell find something below market value even if it means a little DIY work and enjoy never making a personal mortgage again and the benefits in cash flow that come with it.

Enjoy…

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Prasun Choudhury March 3, 2014 at 7:23 pm

You surely have some interesting and valid arguments in favor of paying the house by cash but in some geographical locations it might not be that easy, just considering the cost of the house. From what I hear from my colleagues (I don’t own a house, nor did I try to buy one, so no first hand experience on this), in Bay area (south Bay and Silicon Valley) the avg. 2 bdrm condo price is anywhere between $600K – $900K, depending on the condo, neighborhood, school district, etc. For single family homes, one will rarely find one in decent condition in the Silicon Valley (Cupertino, Sunnyvale, Santa Clara, Mountain View, etc) that will cost below $1 million. This implies, one has to pay out nearly $1 million in cash which might not be easy or even feasible in many scenarios!

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dojo March 4, 2014 at 3:27 am

YES, I WOULD PAY CASH. There’s no way I’d accept getting into debt, if I can prevent it. There’s no such thing as good or bad debt, debt is just that .. debt. And the ‘best’ debt can turn really ‘bad’, if you lose your job or get into troubles. There are many people who lost their houses after losing their jobs. I’m sure they didn’t see their debt as good anymore ;)

So .. if you can pay for the thing, pay cash and leave your future options open. You never know what can happen in 4-5 years and having debt will not make your life easier.

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retirebyforty March 5, 2014 at 8:52 am

Sure, I can see that. I think Mrs. RB40 feels the same way. I like to take on a bit more risk, but I’m getting more conservative as I get older.

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Michelle March 4, 2014 at 7:06 am

For our next home, we want to pay as much of it as we can with cash. I don’t want a loan hanging over my head since I am self-employed.

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Done by Forty March 4, 2014 at 10:47 am

Joe, we ended up paying off our mortgage for many of the reasons you noted. The guaranteed 4.X% return is pretty attractive, from where I’m sitting. We still participate in the markets but if someone offered me a bond paying 4.x% with no interest risk or credit risk, I’d jump all over that, for at least a part of my asset allocation. I don’t know why people are sometimes so against the mortgage paydown or, in your case, avoiding it altogether.

It’s a complicated situation so whatever fits best with your fam is the right decision.

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retirebyforty March 5, 2014 at 8:59 am

I’d jump all over 4% federal bond too. :)

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Dividenden-Sammler March 4, 2014 at 1:15 pm

I have bought my house 12 years ago.
And after the buy, I have pay off the debt as fast as possible!
And now – I´m debt free and can buy shares from good companies… and receive dividends :-)

But: I could never buy the house without debt. That is impossible!

Best regards
D-S

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retirebyforty March 5, 2014 at 9:01 am

That’s what I would do too.

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Chris March 4, 2014 at 9:01 pm

You missed one Joe:
11) Having a house that is paid in full also alleviates the need to stay in the house if you want to move somewhere else while it is being sold for whatever reason (i.e. you stop liking the area, want to move to Hawaii, etc.).

Personally I’d take the paid-for house avenue if I could and so would my wife who is a SAHP just like yourself although she doesn’t provide any income like you do currently).

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Jen March 5, 2014 at 5:05 pm

We just got a mortgage of around $300k. We live in another part of the world, where there is lots of liquidity due to QE money flowing here (read: Asian financial hubs). So the mortagage rate we got is 1.5%. Jaw-dropping, as inflation here is over 3%. We could have paid cash for the home, but of course decided to keep it.
The concern now is where to invest it? Stock markets are all time high all over the world, so I’d rather wait for some correction before pouncing in. Bond yields are ridiculous too. So keeping the money in the bank meanwhile and letting inflation slowly eat it away. On the other hand, the mortgage value also erodes, so it is a wash. Any suggestions?

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retirebyforty March 6, 2014 at 11:23 pm

Wow, 1.5% is awesome. I wouldn’t hesitate with that rate. No, I don’t have any good suggestions. sorry!

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Salim March 7, 2014 at 7:30 am

I wouldn’t pay off the mortgage unless you have the ability to earn a better return than the long term market return. So if your mortgage rate is 4% and you are in 28% tax bracket, your after tax cost for the capital is 2.88% and even a very conservative return over the long term would be at least 5%-6% from a good Index fund, in which case you are earning a net return of ~2-3% of the mortgage amount.
If you paid off your mortgage you give up 2-3% return, however if it let’s you sleep well at night then it would be a better choice and finally you have to be able deal with the volatility of the market.

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retirebyforty March 7, 2014 at 9:41 am

We’re in the 15% tax bracket and the current rate is 4.5%. The effective mortgage rate is around 4%. We already have the majority of our net worth invested in the stock market. That’s why I’m reluctant to add a big lump sum now.

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Bec April 16, 2014 at 5:31 pm

If I had the cash to purchase my primary home I would not borrow the funds to purchase the property.

I understand what a great deal it is to borrow money via a mortgage at a very low interest rate. I also understand how much that interest rate adds up over 15 or 30 years.
I personally avoid paying interest like the plague. I loathe interest that I am paying to a lender. I utilize credit cards for almost all my living expenses to earn cash back, but I pay off the entire balance before the grace period with no exceptions because of my distaste for paying interest. I see this as working against the concept of saving money. Why bother to get something on sale or shop a bargain if I am going to pay more for it in the long run? Perhaps part of this is due to having a low income, but it is my hard-earned money and if I had a lump sum I would go for it. The only reason I would take out part of the purchase price in the form of a loan would be to build my credit report/credit score, since I have heard that a mortgage (paid on-time of course) does wonders for your credit worthiness.

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Jerome April 28, 2014 at 3:03 am

We did buy our house cash, not only but also because with our fluctuating incomes no bank would give us a (decent) mortgage. Looking back for us there were 2 big advantages: having no debt, with all associated bureaucracy, is a great feeling. Period! And buying cash forces you to stay within your budget, thus saving quit a lot of money over the long run. We have numerous friends who have bought bigger and more expensive houses than they originally intended and needed, just because the bank made it possible.

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Happy Healthy and Wealthy Girl May 15, 2014 at 9:54 pm

Hello,
if you have consistent self employment income for more than 3 years, you don’t have much other debts and have a great credit score you will be able to get a mortgage for your house. I was able to get a mortgage last year just working part time.
Good luck.

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Kris May 26, 2014 at 1:49 pm

My biggest question, as I’m retired in my 40’s but my husband still works, is how much can I spend on a house. What % of my assets is wise to invest in a house that we hope to live in . . . maybe forever.

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retirebyforty May 26, 2014 at 11:28 pm

That’s a great question. I’ll have to do more research on that and write a full topic. I’d guess 15-40% would be okay.

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