Buying real estate....pay cash or get a mortgage?

[murphy_p_t]

What analysis has been done on paying cash vs getting a mortgage to buy a property? If our average return from the PP is 9%...how high of a mortgage rate would make sense to take? I didn't find another thread discussing this question.

[WiseOne]

Excellent question!

I'd approach the question in terms of real rates instead of nominal.  The PP's average returns are 3-5% over inflation; the 9% number is actually somewhat misleading because it includes the outsized returns of the 1970s, when inflation was very high.  During a period of very low inflation (e.g. now), the PP's nominal returns are going to be in the 4-6% range on average.

Thus, if you got a 30 year mortgage at 4.5%, you would end up breaking about even if inflation continues at its current rate the entire time.  If we enter a period of deflation or even lower inflation, the mortgage loses - although you could then take the opportunity to refinance if rates drop AND you still have 20% equity in the home.  If instead we end up with a period of higher inflation (with interest rates & PP returns to match), the mortgage wins.  There are, of course, some other considerations:  taxes, mortgage financing costs, your cash flow needs, and the psychological effects of carrying a big debt.

On balance, it's very likely better to go for the mortgage + PP option.  If you take this option, don't skimp on the cash allocation!!  especially if you are close to retirement.

[dualstow]

This is good info for me, too, since that 3.54% loan came in.

[craigr]

It's much more of a psychological question than financial. Because we don't know future returns we can't say with any certainty at what rate a mortgage does or does not make sense except in the more extreme high/low ranges. So a mortgage with an unusually low rate or unusually high rate will dictate a lot of this.

The main question really is whether you like carrying large debt over your head. A mortgage is a negative bond on you. Some people don't like debt and don't want a mortgage. Others think it is OK depending.

I will leave you with a couple thoughts:

1) For the most part, I've never come across anyone yet that paid of their mortgage and really regretted it. I have come across people though that could have paid off the mortgage but instead invested the money and later regretted it (due to investment losses).

2) If you put all your money into your house and have no other reserves you will be what is called "House rich and cash poor." That means if you need money for an emergency it will all be in your house. The traditional narrative is "just get a home equity loan" if you need the cash. But in an emergency (job loss, medical bills, etc.) that is the exact time no lender will touch you!

There are hybrid options to do as well. Instead of putting it all into the house, you can make a very large downpayment. Or you can make a couple extra payments a year which really throws off the compound interest the banks receive over the life of the loan. Those are also strategies many people decide to do.

Lastly, I find mortgages tend to push people into bigger homes than they could really afford without it. So paying in cash can eliminate buying too much house.

[craigr]

I thought this was a good question I see often on investing forums. I blogged about it with some more details on my thoughts:

https://web.archive.org/web/20160324133 ... -mortgage/

[Coffee]

I paid off the mortgage a couple of years ago.  (I'm in my early 40's). 

The psychological relief that knowing you own the roof over your head gives you is priceless.  But then, I'm a worry-er and I'm independently self-employed, so the possibility of my income being "here today and gone tomorrow" is much greater than the next guy.  (I think?)  So, knowing that I have a more than $1800 smaller nut to cover every month is ... a nice thing.

[Libertarian666]

If you buy a house with a non-recourse mortgage, then you essentially have a put option on the house, in that you could walk away if the house was worth less than the mortgage when you wanted to leave. That could be a valuable option, especially if there were a deflationary depression.

[moda0306]

I paid off the mortgage a couple of years ago.  (I'm in my early 40's). 

The psychological relief that knowing you own the roof over your head gives you is priceless.  But then, I'm a worry-er and I'm independently self-employed, so the possibility of my income being "here today and gone tomorrow" is much greater than the next guy.  (I think?)  So, knowing that I have a more than $1800 smaller nut to cover every month is ... a nice thing.

I wonder how much accelerating the pay down of low-interest, tax-deductible debt actually helps our ability to handle an income crisis.

Essentially, the best alternative is probably to put it into a Roth 401k or Roth IRA and into some relatively safe-nominal return assets.

I think saving elsewhere is a better way to put yourself in a position to weather a cash-flow crisis than accelerating the debt paydown would be.  Of course, you have to be careful how you invest it, but even if you lose .5% against your mortgage interest rate because you picked super safe bonds, you still are probably leaving yourself in a more flexibe financial position.

Of course, the closer you get to having the house fully paid off, the more my logic falls through, but if you have 28 years on a 30 year mortgage left, I think paying down the mortgage is actually quite risky considering the alternaties, especially if you haven't maxed out your Roth IRA and 401(k) limits, yet.  By paying it down, you don't improve your cash-flow until maybe 27, 26, or 25 years from now.  That's hardly the best move, IMO.  If I'm going to be illiquid, I damn well better be paid well for it.  A tax-deductible 4% ain't enough.

[Kshartle]

Are you thinking about buying a place Murphy?

[Bean]

I struggle with this all the time, in a very similar pickle.  I have already bought the house and have 27 years left on a 30 year 4% mortgage.

I could pay of the house in a few years, invest and then pay it off, or just invest.

Option of pay it off in a few years: At this low of a rate, you can safely buy IBonds and get close to the rate of the mortgage with the benefit of liquidity when you need it.  When the balances equal, go close the mortgage

Option of invest and then pay it off: What you are getting at though is to arbitrage your debt against the PP.  I can tell you this is exactly what I am doing. The main reasons I feel comfortable with this is the 25% cash portion and that on a rolling 5 year return the PP is yet to go negative. Also, once you factor in write offs, I think my mortgage effective rate is sub 3%, which makes me want to string it out till I have a huge cushion.

Option to just invest: I want out sooner than later, unless they give me the 1% celebrity rate.

[craigr]

In some states like Texas and Florida there is a very protective homestead exemption law. Basically, many creditors cannot take your house for payment. So as an asset protection strategy in some areas, it makes sense to pay off a house as well.

* Not an asset protection attorney, so seek advice if you think the above would apply.

[Tyler]

I've been back and forth on this about 100 times.

I'm naturally inclined to pay off my mortgage, as I'm nearing an early retirement (within a year if I play it right) and really like the ideas of minimizing necessary cash flow and having zero debt from an antifragile perspective.  That said, I lucked into a 15-year mortgage at only 2.875% (below the average inflation rate) late last year, and while my home value is only 20% of my portfolio I do like the idea of having more accessible (non-tax-deferred) cash in early retirement just in case.  And based on my PP calculations, the odds of the PP beating 2.875%/yr over any given 15-year period are very high.  So I can see both sides, and the "keep your options open" side of me has avoided paying off the mortgage to date. 

Generally speaking, I think that at a reasonable interest rate paying off the mortgage or investing in the PP are both perfectly good options.  Both beat risky or wasteful alternatives by a longshot. 

[WiseOne]

Glad I'm not the only one - I've wrestled with this as well!!

I started out paying extra on the mortgage to try to bring down the balance, which eventually paid off as I also got one of those beautiful 15 year mortgages at 2.75%.  Now I'm just making the regular payments and saving the rest.  The goal is to have an accessible money pool equal in size to the mortgage so that I can eventually have the luxurious option of either paying it off or using the passive earnings to make the monthly payments.  Having cash available is, to me, far more valuable than not carrying mortgage debt - although I can well understand how some people might take the opposite view.

The only fly in this ointment is that the "saving the rest" part hasn't exactly worked out as planned.  I'm getting completely stiffed at work (salary FAR lower than it should be considering what I bring in) but I've not wanted to say much about it because I've been having to take a lot of time off for parental care issues.  Anyway I'm still managing to save a little but at the cost of skimping a bit on the 403b.  I'm trying to work out whether selling my place and moving to a cheaper place closer to work would win financially - I think it does, if I stay there 10 years, so I might do it.

[notsheigetz]

I'm in the don't pay it off camp, but like Craig and others have said it's more about psychology than rational investing. The idea of owning a house free and clear is nice but I just feel better having the money sitting in my PP. Plus I don't get attached to things like houses. After a few years living in one I get tired of it and am ready to move on. Kind of sorry I bought the one I'm paying off now.

[One day at a time]

For me, the discovery of the PP made a big difference in this debate.  While having the mortgage paid off would be great, it seems there are some significant considerations for the PP (if one has to choose):
1.  Liquidity is the best security in a crisis. 
2.  With the Feds applying financial repression right now, taking out a very low interest rate loan on a real asset seems like one of the few options that could make sense in this environment. 
3.  I'm assuming PP money in a retirement account is more protected than house equity from creditors/lawsuits if you don't live in a homestead law state (or whatever it's called in FL and TX.)  I have no idea if this is actually true, but it seems like this would be correct.

As a side note,  Bill Bernstein's latest book, Deep Risk, seems to add some interesting thoughts on this debate:  (1)  inflation is the far more likely economic risk scenario in modern times, (2) Gold has had more deflationary rather than inflationary protection, and (3) (I think he said) a 30 year fixed rate mortgage is one of his recommended options as an inflation hedge.  If one believes Bernstein about gold, then the mortgage might be a good compliment to one's overall PP strategy.     

[travelingheelfan]

Some people feel safe and secure paying cash for their own home and that's fine.  I feel better with having a mortgage (30 year at 3.25%) and having more liquid assets if/when Mr. Murphy decides to pay us a visit.  You can't eat sheetrock.

[dualstow]

Some people feel safe and secure paying cash for their own home and that's fine.  I feel better with having a mortgage (30 year at 3.25%) and having more liquid assets if/when Mr. Murphy decides to pay us a visit.  You can't eat sheetrock.

You mean Murphy of Murphy's Law and not the OP, right? 

[moda0306]

Liquidity is so huge.

I tend to group "Random Life Events" into my "portfolio" of eventual investments.  Investing in equities and in tax-efficient ways might help me in some important ways long-term, I want to be poised to "rebalance" my liquid portion of my portfolio into REAL life decisions that require a cash flow of some sort, but have massive rates of return when you look at their overall affect on your finances.

The ability to jump on a good deal, big or small.

The ability to find the doctor you WANT to have help you, not the one the hospital assigns to you.

The ability to do home-improvement projects correctly and thoroughly.

The ability to bum gas from someone.

The ability to refinance quickly during a very quick, hard drop in interest rates.

The ability to bail your kid or sibling or parent out of a messy situation or help them out

Whether it's $100 in my pocket, $2,000 in my safe, $20,000 in my savings account, or $150,000 of Roth IRA basis, I want to be LIQUID with at least a decent chunk of my wealth, and poised to make those decisions from a position of strength.

This is also why proper insurance is important.

[k9]

As a side note,  Bill Bernstein's latest book, Deep Risk, seems to add some interesting thoughts on this debate:  (1)  inflation is the far more likely economic risk scenario in modern times, (2) Gold has had more deflationary rather than inflationary protection, and (3) (I think he said) a 30 year fixed rate mortgage is one of his recommended options as an inflation hedge.  If one believes Bernstein about gold, then the mortgage might be a good compliment to one's overall PP strategy.   

The thing is, having a hard asset like a home IS an inflation hedge by itself. If you buy it with your cash and inflation is suddenly 100%, then your house is worth 2x its buying price (on average). Having a mortgage on top of that is even better, for sure : you not only have an inflation hedge but actually profit from inflation ! Well, it cuts both ways. If inflation drops or stays very low, if what you can get from your cash / LTT is lower than your mortgage rate, you lose. That's called using leverage, and that's a risky speculative bet.

I'd rather not profit from high inflation if it ever came, but being hedged anyways, rather than having to pay a few percents every year to my bank with cash that is harder & harder to earn (and for an asset that is worth less & less) in a deflation situation.

Finally, don't forget your bank/broker earns money when you have a mortgage and/or when you buy financial assets. Using leverage to buy financial assets is the best gift you can do them. If there was an easy way to earn more than x% for sure on the next 30 years, why would they lend you that money at that rate ? Why wouldn't THEY buy 25% ST, LTT, gold & stocks ? They don't even have to pay broker fees, they are the broker !

Well, that's just my advice, & I think it is far more important to first have a cushion of liquidity before attempting to optimize things. Now, the size of that cushion is a personal matter for sure.

[Kshartle]

The thing is, having a hard asset like a home IS an inflation hedge by itself. If you buy it with your cash and inflation is suddenly 100%, then your house is worth 2x its buying price (on average). Having a mortgage on top of that is even better, for sure : you not only have an inflation hedge but actually profit from inflation !

Very bad inflation can really harm the economy though and since your house is stationary it's stuck in a very bad place. The value won't appreciate like portable wealth (gold, silver, platinum......bitcoins?)

I think there are stories from Weimar of people scooping up properties with just ounces of gold at the height of the hyperinflation.

Granted 100% inflation isn't hyperinflation but if it happens in a very short period (a couple years) it should be pretty devasting.

I would not consider your personal home as a substitute for gold. Maybe it would be better to consider it 50% gold and 50% stocks since prosperity should drive the value up as well as inflation.

Just a thought.

[k9]

Sure. Gold is too valuable IMHO to be substituted by anything else, even physical real estate. But I think buying too much gold on leverage is pretty risky, too. The hard part is finding the right balance...

[Libertarian666]

Sure. Gold is too valuable IMHO to be substituted by anything else, even physical real estate. But I think buying too much gold on leverage is pretty risky, too. The hard part is finding the right balance...

Do not use leverage if there is any possibility, no matter how seemingly remote, of getting a margin call.
Don't ask me how I know. 

[stone]

We sort of have a mortgage but it is a fully offset "offset mortgage". Basically it is a combined current account and mortgage where you only pay interest on the difference between what you owe and your account balance. It means that, if needs must, we could instantly draw on the money we have paid to offset the mortgage and yet we don't pay any mortgage interest. I guess it is a sort of compromise between being liquid and yet not forking out interest payments. Those sort of mortgages are (certainly were) standard in the UK but I have no idea about elsewhere.

[k9]

Sure. Gold is too valuable IMHO to be substituted by anything else, even physical real estate. But I think buying too much gold on leverage is pretty risky, too. The hard part is finding the right balance...

Do not use leverage if there is any possibility, no matter how seemingly remote, of getting a margin call.
Don't ask me how I know. 

Maybe I'm abusing the term here, but what I'm calling "buying gold on leverage" in this context means "buying gold while you still have a mortgage". I'm not talking about getting into debt just to buy gold.