When Paying Cash Is More Logical Than Taking a Mortgage

By on September 30, 2014

People are always debating what is the better option, buy property, a house or land, cash or take out a mortgage. For people who do not have the money to pay cash, the question is moot and academic, but for people who have a cash pile sitting in the bank, the question raises some points that need to be discussed a little further.

Many people, among them financial experts, advise that using bank money to buy property is the best way to go, while others maintain that buying cash is better. And if you are someone with an eye for observation, you will notice that those who advocate using leverage are usually those who are professions related to the finance or real estate industry. Those who champion the use of cash are usually those who are already successful and have the money to do so. So would you prefer advice from professionals or people who are successful and knows the ins and outs of money?

The main position of those in favor of taking out a mortgage to buy a house or some other property is you can use your cash for other things like investing or putting up a business. They say that with your earnings from these activities you will be able to pay your loan and ensure a more stable financial future. Apart from the earnings from your investments, the interest you pay on the loan is also tax deductible, an incentive to take out a mortgage instead of paying cash.

The position of those advocating a mortgage appears to be sound and logical. Indeed why not use your cash to earn more money and let the bank buy your house?

The problem with the strategy is you can never be sure whether you can really earn more money from your investment enough to cover your amortizations. The problem seems to stem from the fact that you pay more for a property when you purchase it through a bank mortgage than when you pay cash for it because of course you have to pay interest to the bank.

People who have studied the issue at length and have done some calculations and found out that even if you earn 11% interest on stock investments and you pay only 7% interest on your mortgage loan you do not actually earn much. At least what you save is not enough to offset the precarious situation you have put yourself in. Carrying a great amount of debt is not something that gives you a feeling of security. Your worry turns into full anxiety if you lose your job or the stocks you hold lose some of their value.

pay cash to buy houseSome say that with the money you are supposed to buy your property with you can go into business. That is true, but then if your business unfortunately is not successful, as you have expected, you are left with a mountain of debt you may not be able to pay. And you will be left with selling your house to raise cash for repayments to creditors. Unless… you are one of those people who have a bad habit of not paying back what you owe.

A mortgage is still advisable if paying cash might result to your family living in difficult financial circumstances.  In this kind of situation the best option is to put up a hefty down payment and take out a mortgage to cover the balance. You don’t have to undertake full leverage and expose your cash flow to the effects of interest repayments. You will also have enough left for your family while reducing your loans considerably.

When do you buy a property for cash? Every time you have enough money you do it. Buying cash has advantages. You usually pay less when you buy cash and best of all you do not have to worry about debt and amortizations.

If you take on a 10-year car loan at a flat annual rate of 2.5%, you will eventually repay $50,000 for a $40,000 loan. That is a whopping 25% extra on your original principle. That is the evil power of long term borrowings if you are on the side of the borrower. Of course, if you are the lender, you will probably be smiling from ear to ear.

For a mortgage that can stretch out over 20 to 30 years, and at a much larger quantum, you will be looking at a pretty substantial amount on accumulated interest payments. You might think that by taking a huge mortgage can allow you to use your own funds for generating a higher return over the long terms. But here is a thought for you. If you will eventually an extra 25%, this also means that you will make that 25% for doing nothing if you are to pay cash. Trying to generate a return takes work and puts you at risk. Fully paying for a house in cash allows you to immediately “cash in” on that 25% now. And you don’t have to put in any extra work and effort.

The main problem that home buyers face when they doubt the logic of paying cash is frequently a psychological one. They have spent years stacking up their money and are not mentally ready to let go of a huge portion of it, or all of it, at a go. But if you put the numbers together, paying cash can actually be the most logical thing to do, especially when you are not an active investor.

There is no shame to admit that you are not an investor. Investing is a stressful hobby and the majority of people do not invest their money in complex sophisticated investments. If you have enough cash in the bank to fully pay for your real estate purchase, there is a strong reason for you to go ahead. There is no guarantee that you will make better use of the money and generate great returns in the long run anyway.



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