Paying Cash for Your Home: Is it a Good Investment?

Wednesday, Sep 26, 2007

If you could pay for your next home with cash, why wouldn't you? This could be one of the nicest problems that you'll ever have.

Most homeowners spend decades paying down their mortgage loans. When it's all said and done and the last payment is complete, most people pop a bottle and celebrate. Why in the world, then, would you ever take on a mortgage loan if you actually have the money to buy a house in cold, hard cash?

Time is money


The traditional answer is that you could put that money to better use. Let's say you have a 6 percent interest rate on your mortgage loan, and you fall ino the 33 percent tax bracket. After deducting mortgage interest from your taxes, you'll end up with an effective 4 percent interest rate. If that's readily available in the market through certificates of deposit (CDs) or money market accounts, you could have a higher return on your money.

Here's how it works: You'd take the loan money and invest it into a 5 percent savings account for a tiny (but welcome) 1 percent return on your investment, or into stocks for an even greater return if your risk tolerance is higher. That's the magic of offsetting interest payments with investment returns.

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While it sounds great, there are downsides to the battling interest rates strategy. First, your financial life will become more complicated. In addition to monitoring your monthly mortgage payment, you'll have to keep an eye on your investments.

The tax issue, which is easy to forget, cuts both ways. You'll pay tax on your interest income, after all, so that 5 percent yield will turn into 3.3 percent after tax. Remember that you need to beat the original mortgage rate by a percentage point for that plan to work. If you want a 1 percent effective return in our test scenario, you'd need a 7.3 percent return on your investment for it to pay off.

An unpredictable life


An all-cash home payment ties up your assets in a very real way. If you need a sudden burst of money for medical bills, a dream vacation, or to pay for college tuition, it won't be readily available. In a tight mortgage market, like the one we're currently experiencing, you might not be able to draw equity out of your home as quickly and easily as you need to. If you had a mortgage payment instead, with the money parked in more accessible investment vehicles, you could easily pay those unexpected bills.

There are financial pros and cons in the all-cash strategy. But don't forget about the emotional impact. Owning your home free and clear is worth a little celebration whether you paid down the mortgage or bought it outright. It offers a peace of mind that no loan can ever match. In the end, that may be enough to outweigh the slim financial rewards of reinvesting the loan balance. That house is yours, and no bank can ever take it away.

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