Picture this: You find the perfect house, forgo the bank and the associated mortgage paperwork, and break out your checkbook to purchase a home outright. While paying cash for a home is a still a far-fetched dream for many people, it’s actually becoming more common in the real estate market. The National Association of Realtors reports that the number of homes bought with cash has increased to 32% in January of 2011 versus 26% in 2010.
The statistics are even more striking in some of the real estate markets hardest hit by the recession. In Southern California, for example, approximately 30% of home sales made in January were paid for in cash, while in cities like Phoenix, Arizona and Las Vegas, Nevada that number is topping 50%.
What is driving this increase in cash home purchases? While the factors affecting the increase in buying homes with cash are not completely known, there is speculation that the increase is being driven by a combination of falling home prices in the wake of the recession, more complicated financing and stricter loan standards at the banks, and possibly bargain hunting among wealthier Americans seeking to cash in on a potential housing recovery.
Regardless of the reasons, however, paying cash for a home is becoming more and more common within today’s economy. And for those who do have sufficient cash on hand to purchase a home outright, the question remains: is it a good idea?
Running the Numbers
A logical place to start the evaluation of whether purchasing a home with cold hard cash makes financial sense is with the cost of buying a home outright versus the time-based loan payments that would be made with standard financing options.
For argument’s sake, we will assume that we are purchasing an average home, at average interest and financing rates. The median home price in the U.S. currently stands at $177,000. For simplicity, we will assume a 20% down payment, an interest rate of 5% on a 30-year fixed rate mortgage loan and 4% on a 15-year fixed rate loan (which more or less reflect the current market conditions).
So how much would you pay for a house that currently costs the U.S. median price of $177,000?
- Cash Payment: There’s no math required on this one – you would pay the sticker price of $177,000.
- 15-Year Fixed Rate Mortgage (20% Down): Including your 20% down payment, the total cost of a median priced $177,000 home, financed with a 15-year mortgage will have cost a total of $257,119 after 15 years of interest and principal payments.
- 30-Year Fixed Rate Mortgage (20% Down): Including your 20% down payment, the total cost of this $177,000 home, after 30 years of interest and principal payments will cost $375,425.
As you can see from the numbers above, if you can swing the initial cost, paying cash for a home will obviously save a great deal of money over time, but there are other benefits as well.
Advantages of Paying Cash for a Home
1. Easy to Buy and Sell
By cutting out the bank, you are taking away a great source of uncertainty. You won’t have to sit in front of a mortgage broker and hope that your credit score will result in favorable loan terms. The ability to pay cash for a home, or accept cash as a seller, takes a great deal of stress out of the financial transaction, and accelerates the purchasing process. Paying cash might also help you negotiate a better price on the purchase, as the seller is assured a quick and painless transaction.
2. No Mortgage or Rent Payment
For most of us, housing costs make up a huge amount of our monthly expenses. Imagine the potential return you would get from diverting that money to saving and investing in the stock market, a form with a much higher potential return.
3. Sense of Security and Ownership
If you lose your job or hit financial hard times, you cannot be foreclosed on since you already own the home completely. This means that regardless of how bad things may get financially, you are ensured a place for your family to lay their heads at night.
4. Available Equity
Hit financial tough times? You will have total equity in your home that you have the ability to tap in an extreme emergency. However, an adequate emergency fund should be your first step.
5. Less Market Fluctuation Concerns
The fact is that when you own a house outright, you cannot get upside down on your mortgage loan. Regardless of what the market does, you are able to make value-based decisions on what to do with your property. If you have to move and rent out the home as a landlord, you don’t need to worry about clearing enough to make the mortgage payments. If you must sell for a loss, as long as you have lived in the home for several years, chances are that the savings you have gained from not paying the mortgage for several years is enough to offset the loss in principal on the home.
Disadvantages of Paying Cash for a Home
While buying a home for cash seems like a no-lose situation, there are a few downsides to keep in mind.
1. Loss of Liquidity
Lets face it. Paying that much money for anything upfront is going to cost you a great deal of liquid assets in the form of cash. That’s why you should only buy a home outright if you are still able to have a comfortable cushion of cash for emergencies. Cash tied up in real estate is not easily tapped in the case of financial troubles, except through a sale or tapping equity.
2. Lack of Leverage
Although most of us are in a hurry to pay off debt, being leveraged in real estate can actually be one area where maintaining some debt has an upside. Because your mortgage payment is locked in, if you are able to get a very favorable interest rate, during inflationary periods, you may actually make money by having a mortgage due to the effects of inflation.
3. No Tax Advantage
Many mortgage proponents argue for the favorable tax treatment of mortgage interest in the American tax code, and indeed the tax treatment of mortgage interest are one of the biggest incentives for many homebuyers. Buying a home with cash will not provide any tax deductions.
Paying cash for a house is becoming more common in today’s marketplace, and judging by the reasons above, it is clear why. Paying cash for a home offers some great benefits if you are able to swing the initial cost. It is, however, a very big financial commitment, and ties up liquid assets in a major way. If you can buy a house outright and still maintain an adequate cash cushion, it may be a great financial move.
What do you think? Is it a wise decision to purchase a home with cash without a mortgage loan?