In the face of tighter lending restrictions and rising interest rates, more home buyers are skipping out on a mortgage altogether in favor of paying cash for their dream property. Through the second quarter of 2014, nearly 40% of home sales were completed with cash according to RealtyTrac. While there are some definite advantages associated with going this route, there are a few potential drawbacks to keep in mind. If you’re undecided about whether you should buy a home with cash instead of opting for a mortgage, here’s a brief rundown of the pros and cons:
Pros:
1. No bank hoops to jump through
Aside from finding the right house and getting the seller to agree on a fair price, the most bothersome part of buying a home is dealing with the bank. Applying for a loan typically means filling out a mountain of paperwork and despite your best efforts to get all of your documents together, there’s inevitably going to be something that you’ve overlooked.
Assuming you’re approved for a mortgage, you still have to deal with the closing process which means signing off on even more forms. Depending on how closely your application is scrutinized and how on top of it your loan officer is, it may take two months or more before the keys to your new house are actually in your hand. Paying cash allows you to sidestep these hassles altogether.
2. Your credit’s not a factor
Although lenders are expected to relax restrictions for borrowers somewhat in 2015, your credit still plays a big part in determining whether you’re able to qualify for a mortgage. If you’ve had trouble in the past with delinquencies or even a bankruptcy, you’re going to face some much bigger obstacles to approval and the odds of locking in the best interest rate are slim.
The nice thing about being able to pay cash for a home is that the seller’s not going to care what your credit history looks like. Those past mistakes that could make you seem less credit-worthy in the bank’s eyes don’t come in to play when you’re bringing a nice pile of money to the table.
3. There’s no interest to worry about
One of the traps that first-time home buyers often fall into is thinking that the purchase price of a home is what they’re actually going to pay for it when they take out a mortgage. A quick glance at the loan amortization table tells a much different story.
Let’s say, for example, that you’re buying a home for $150,000 with an interest rate of 4.5%. If you go the conventional 30 year route, don’t pay anything extra towards the principal and don’t refinance, the house is going to cost you nearly $127,000 in interest alone. When you’ve got cash to close the deal with, you’re essentially keeping thousands of dollars in your pocket over the long term.
4. It may make you more attractive to the seller
Selling a home can be just as stressful as buying one, especially if you need to unload the property quickly but the buyer is having trouble with the financing. If you know that the house you’ve got your eye on has been on the market for awhile or that the seller is trying to wrap things up as quickly as possible, you may be able to use your cash position to negotiate a better deal.
For example, you could ask them for a small reduction in the purchase price or get them to agree to cover the closing costs. In some situations, they may find it worth it to take a small financial hit in order to walk away with their pockets full and not have to deal with a mortgage broker.
Cons:
1. You could get better returns if you invested the money elsewhere
Investing is really a numbers game and buying a home, historically, isn’t something that offers a tremendous amount of growth. While property values have steadily been climbing upwards, owning a home generally doesn’t yield the kinds of returns associated with stocks, mutual funds or other investment vehicles.
For instance, assume that instead of paying $200,000 in cash to buy a home, you used $40,000 for the down payment and invested the rest. If your investments earn a return of 8% that first year, that adds up to a cool $12,800. Assuming an average annual appreciation rate of 5%, the home would pick up an extra $10,000 in value. Once you factor in the cost of things like property taxes, homeowner’s insurance repairs, the margin of return on the home narrows even more, which suddenly makes parting with all that cash seem a little less attractive.
2. It means sacrificing a certain amount of liquidity
Unless you’ve managed to accumulate a substantial cushion of savings, buying a home in cash usually means parting with a big chunk of change all at once. If you’re pouring your entire life savings into buying the property, you’re leaving yourself in a dangerous position if an emergency comes up or the house needs some expensive renovations. At that point, your only choice might be to use a credit card to cover the gap, which can create more financial problems down the road.
If you’ve got a job that pays well and your expenses are fairly low, you should be able to rebuild your savings in a relatively short amount of time but you’re still taking a gamble by draining your accounts all at once. When your income is unstable or there’s the chance that your job situation could change, you need to make sure you’ve got a backup plan in place before pulling the trigger.
3. You miss out on the tax break
One of the perks of taking out a mortgage is the fact that you can deduct the interest you pay on your taxes each year. If you normally owe Uncle Sam money, that deduction can count for a lot when April 15th rolls around. When there’s no mortgage to speak of, that’s one less write off you’re able to claim. If you’re able to deduct business, education, moving or charitable giving expenses, that can offset some of the loss but you need to be aware of how buying a home in cash can impact the size of your tax bill or your refund.
The Bottom Line
Despite the fact that cash home purchases are gaining ground, that doesn’t mean they’re right for everyone. Taking out a mortgage may seem like a burden since you’re tying up money for the monthly payments but the fact that the majority of home-buyers still choose this option says a lot about its appeal. Ultimately, it comes down to how comfortable you are with parting with the money all at once versus stretching it out over the next 20 or 30 years.
What method did you use when purchasing your home?
