Imagine how much easier life would be if you could just write a check for your next home. No mortgage application process, no monthly payments, the security of owning your home outright — sounds like a no-brainer, right?
Not necessarily. Paying cash for a home isn’t always the right financial move, even if you happen to have a few hundred thousand dollars sitting around collecting dust.
If you’re considering buying a home with cash, make sure you know what that means for your bottom line and long-term financial goals.
Running the Numbers
The logical starting place in the decision to finance or pay with cash is the cost to borrow.
According to Zillow, the median home price in the U.S. is $248,857 as of early May 2020. Current interest rates sit at around 3.5% for 30-year fixed-interest mortgages and around 2.75% for 15-year fixed mortgages.
How much would you pay for a house that currently costs the U.S. median price of $248,857? Let’s take a look at the numbers.
- Cash Payment: No math required here. You pay the sticker price of $248,857, end of story.
- 15-Year Fixed Rate Mortgage: If you put 5% down, that leaves you with a mortgage loan of $236,414. At 2.75% interest, a 15-year mortgage costs a total of $288,784.80 after 15 years of interest and principal payments.
- 30-Year Fixed Rate Mortgage: Assuming the same 5% down and loan amount of $236,414, a 30-year mortgage at 3.5% interest costs a total of $382,179.60 after 30 years of interest and principal payments.
If you can foot the bill without a mortgage, paying cash for a home obviously saves a great deal of money over time — in the vicinity of $50,000 to $150,000 in dodged interest for the average homebuyer. But the benefits of paying in cash don’t end there.
Advantages of Paying Cash for a Home
Beyond the tens of thousands of dollars in savings on interest, homebuyers capitalize on a range of other advantages when they pay cash. Consider the following pros if you have the money to buy your next home in cash.
1. Negotiating Power for a Lower Price
There’s an old saying in real estate that cash is king. And it remains largely true, even in an era when cash purchases are a rarity.
Sellers don’t just want the highest possible price. They also crave certainty. They hate the idea of accepting an offer, taking their home off the market, turning down other offers, and waiting around for a month only to have the contract fall through due to financing.
Cash offers reassure sellers that you will absolutely close, you aren’t dependent on anyone else to be able to do so, and you don’t have to wait around for fickle underwriters’ approval.
Eliminating the lender from the equation also means you can settle far faster. In exchange for a faster, more certain settlement, many sellers are willing to negotiate on price, often accepting far less than their other offers.
2. No Risk of Your Deal Falling Apart From Financing
The seller isn’t the only one who doesn’t want the contract to fall through. It’s heartbreaking to lose the home of your dreams because your lender changed its mind at the eleventh hour, just before you’re scheduled to settle.
By paying in cash, you’re not subject to lenders’ whims. There is no back and forth trying to get approved for a mortgage, submitting documents and then more documents and still more documents. No nail-biting or worrying whether your lender will delay the deal.
You control your own destiny, and you know for certain that you can fund the purchase.
3. No Mortgage or Rent Payment
For most of us, housing costs make up our largest monthly expense. By eliminating this cost, you dramatically lower your living expenses.
If you lose your job or hit financial hard times, you cannot be foreclosed on because you already own the home free and clear. Regardless of how bad things may get financially, you guarantee a place for your family to lay their heads at night. That peace of mind has its own intrinsic value.
Without a monthly housing payment, you can funnel more money into income-producing investments, travel, or simply a higher quality of life.
4. Lower Expenses Mean Lower Risk
Lower living expenses mean you need less income to survive. That means it’s easier to reach financial independence and retire.
Imagine you save $1,500 per month by paying cash for a property, dropping your monthly living expenses from $4,500 to $3,000. If you’re following a 4% safe withdrawal rate for your retirement planning, that means saving up a nest egg of $900,000 instead of the $1,350,000 needed to generate enough income to cover your living expenses in retirement.
Eliminating debt also reduces risk in your investment portfolio. Stocks fluctuate and occasionally plummet, but using money to avoid debt provides a guaranteed return on investment.
As you get closer to retirement, it increasingly makes sense to reduce your stock exposure and eliminate debts to provide more predictable returns.
5. Lower Closing Costs
Although often overlooked by buyers, saving money on closing costs is a compelling reason to buy in cash.
Mortgage lenders charge more than just interest. When you take out a mortgage, you can also expect thousands of dollars in lender fees.
It starts with a sales commission measured in “points,” where 1 point is equal to 1% of the loan amount. When loans are measured in hundreds of thousands of dollars, points add up quickly.
Beyond points, lenders love to pile on what the industry calls “junk fees.” These are flat fees that lenders make up: processing fees, administrative fees, underwriting fees, document preparation fees, and whatever else they can come up with to squeeze more money out of borrowers.
Then there are title fees. Although you still need to hire a title company even if you buy in cash, lenders often press borrowers to use their title company, which may just happen to be twice as expensive as the company borrowers prefer to use.
6. No Mortgage Insurance (PMI or MIP)
If you finance more than 80% of the purchase price of a home, lenders require you to buy mortgage insurance.
It goes by several names. Conforming mortgages call it “private mortgage insurance” or PMI, while FHA loans call it mortgage insurance premium (MIP). Whatever you call it, it’s expensive, and it doesn’t help you in the slightest.
Mortgage insurance doesn’t protect you; it insures the lender against your default. If you stop paying your mortgage and the lender takes a loss, they can file a claim to get their lost money back.
But you’re the one who has to pay for it. Mortgage insurance usually costs borrowers well over a thousand dollars every year. It’s essentially lost money.
Although some loan programs allow you to apply to have it removed from the loan once your loan drops below 80% of the property value, FHA no longer does — it requires it for the entire life of your loan.
You can dodge this bullet by borrowing less than 80% of the home’s purchase price, and you avoid it entirely by buying in cash.
7. No Risk of Going Upside-Down
When you own a house outright, you cannot get upside-down on your mortgage loan. There’s no risk of being forced to stay in the home simply because you owe more than the home is worth.
Regardless of what the market does, you’re able to make value-based decisions on what to do with your property. If you have to move and opt to rent out the home as a landlord, you don’t need to worry about clearing enough to cover both the mortgage payment and nonmortgage expenses.
8. Less Temptation to Overspend
When buyers take out a mortgage, they tend to think in terms of monthly payments rather than the total cost of buying the home. After all, it’s easier to wrap your head around $1,500 per month than it is to conceive of $300,000.
But when you have to hand over $300,000 of your own money, it makes the cost more tangible. Buyers who pay in cash are less likely to overspend because the money doesn’t just represent a promise to pay it back one day — it goes from being yours to belonging to someone else.
Then there’s the fact that you can spend only what you actually have if you buy in cash. If you have $200,000 and commit to buying a property in cash, then you have a hard price ceiling of $200,000.
Disadvantages of Paying Cash for a Home
So everyone should just save up a few hundred thousand dollars and buy a home in cash, right?
Not exactly. While there are plenty of advantages to this strategy, you have to weigh them against the following downsides before deciding what’s right for you.
1. Opportunity Cost
Yes, buying a home in cash saves you money on interest. But those savings might be less than you could earn on your money by investing it.
Historic stock market returns are significantly higher than the 2.75% to 4% interest today’s mortgage lenders charge. More than double, in fact: stocks have historically returned 7% to 10%, depending on which index, region, and capitalization level you consider.
In our example above, a homebuyer taking out an average 30-year mortgage on a median-priced $248,857 home would spend $382,179.60 over the course of those 30 years. Call it $160,000 in interest and fees after accounting for closing costs and PMI.
Now imagine you took $248,857 and invested it in the stock market, earning an average return of 8% over the next 30 years. If you never invest another cent but let the growth and dividends compound, at the end of 30 years, you’d have $2,504,163.
That’s a far cry from the $160,000 you’d save in interest, closing costs, and PMI by paying for the home in cash.
2. Lack of Liquidity
When you buy a home with cash, you lock up all that money in the home and can’t easily access it.
To access it, you’d have to either sell the house or take out a mortgage on it. By doing the latter, you’d spend more than you would have if you’d bought the home with a mortgage in the first place because you’d have to pay for closing costs like title fees all over again.
That kind of poor liquidity leaves little flexibility for rearranging your asset allocation and moving money from one investment to another.
3. No Mortgage Interest Deduction
If you itemize your tax deductions, the mortgage interest deduction is an easy way to slash your taxable income by thousands of dollars each year.
It effectively reduces the real cost of your loan. If you pay taxes at the 24% tax rate and you pay 4% interest, then your net cost is closer to 3% interest if you can write off mortgage interest.
Keep in mind that if you take the standard deduction — as many more middle-class taxpayers are doing in the wake of the Tax Cuts and Jobs Act of 2017 — you wouldn’t benefit from this deduction anyway. It only reduces your taxable income if you itemize your deductions.
4. Inflation Reduces Real Housing Payment Over Time
When you take out a fixed-interest loan, you lock in your principal and interest payment for the full term of the loan. Your payment will be the exact same amount 25 years from now if you take out a 30-year loan today.
Your payments remain unchanged in nominal dollars, but not in inflation-adjusted dollars.
Today’s dollar is worth significantly less than the dollar of 25 years ago — 41.3% less, to be exact, per the U.S. Bureau of Labor Statistics. A loan taken out 25 years ago with a $1,000 monthly payment was the equivalent of $1,736.48 today.
Put another way, your monthly payment would have effectively dropped from $1,736.48 to $1,000 by locking in your payment amount 25 years ago.
Therefore, 25 years from now, your monthly payment will likely represent less money in relative purchasing power. Inflation works in your favor when you take out a fixed-interest mortgage.
5. Missing Out on Forced Savings
Not everyone is disciplined about saving money. Most people save only whatever they have left over at the end of the month.
Taking out a mortgage forces you to put a little money toward building equity every month. With each payment you make, you gradually pay down your principal balance, expanding the gap between what your home is worth and what you owe.
That equity matters. It’s one reason why the median homeowner has a net worth 44.5 times higher than the median renter, at $231,400 versus $5,200.
6. Homeownership Delays
Have most of the money you need to buy your next home in cash, but not all of it?
If you want to buy in cash, that will delay your purchase. You have to sit around and wait until you have all the money you need set aside in cash — and not just for the purchase price. You also need money for closing costs, your insurance premium, prepaid property taxes, and more.
Or you could simply put down 20% to avoid PMI and move into your new home immediately.
There’s no one-size-fits-all answer to whether you should buy a home in cash or finance it with a mortgage. The financial realities of a 25-year-old are quite different than those of a 70-year-old, for example.
The younger you are, the more sense it makes to finance a home with a fixed-interest mortgage. If you’re retired or approaching retirement, the security of less debt and lower monthly expenses becomes more valuable for you.
The opportunity cost alone is an enormous factor, particularly for homebuyers under 50. Personally, I would borrow money all day long at 4% if I could invest it to earn 8%. Borrowing at a low rate to earn at a higher rate is how banks turn a profit, and it’s how I earn money as a real estate investor.
Consider your own personal needs and risk tolerance carefully, and be careful not to strip every penny from your emergency fund and retirement accounts simply to buy a home. Mortgages are cheap in today’s market, after all.