Paying cash for a house

[matjone]

I am thinking about purchasing a house and am trying to decide whether to borrow or pay cash.  Paying cash would probably cut my investment capital in half, but it would probably cut my heart rate a few BPM too.

 

I know mathematically you are better off borrowing and keeping the money in the market. But life is not lived in an excel spreadsheet, and there are probably millions of examples of people who thought they were better off borrowing and regretted it.  And who knows, maybe the lower heart rate gives me a longer life and enough extra compounding time that I come out ahead on the spreadsheet.

 

So, what do you think?  Anyone else ever thought seriously about this?  I know we aren't financial advisors here, and the typical response will be that it is up to me and I have to decide for myself, so I want to clarify that I am not looking for someone to tell me what to do, but rather just trying to start a discussion and get opinions from people wiser and in many cases more experienced than myself.  Thanks

[CorpRaider]

Yeah, I think this is going to be one of those levels of comfort with risk answers, but I would probably take as much sub 4.5%, 30 year fixed, tax deductible debt as I could get...

[ERICOPOLY]

Even when I had just $5,000 to my name I was investing the money.  I had no house yet.

 

Then one day I buy a house -- does this mean that I'm freaking out suddenly that my investments are just a gamble and they should all be dumped into paying down the mortgage?

 

That gamble was there all along, from the very first $5,000 I had invested.  It just seems harder to ignore once you've decided to buy a house.

 

Same thing goes for saving for retirement.  Do you dare invest the money that you'll need in the future to pay for your food? 

 

I'm pretty sure 100% of financial advisors say that you should risk your retirement food money by investing it today.

[no_free_lunch]

Personally, I would buy the house and have no debt.  You will still have significant investments.  I know it makes no sense financially, but only if you can make certain assumptions regarding your future employment and the performance of your investments.  I personally have seen people go through severe financial hardship and without getting into the particulars it occurred to me that having a house free and clear puts you in a very good spot. 

 

We are living in a world with zero interest rates and quantitative easing, unprecedented monetary policy.  You have financial gurus like watsa with huge equity hedges.  Equity markets are at all time highs.  Maybe it's not a bad time to be a little conservative?

[ERICOPOLY]

Depends also on how you have it invested.  You don't have to take big risks for a big potential payoff. 

 

4.5% fixed-rate mortgage only really costs you 2.43% if you are faced with 46% income tax rate in California.  (there, I just explained part of the high cost of house prices relative to rents in California)

 

You can make 2.46% in the California medium-term tax-exempt muni bond fund from Vanguard.  That fund has an average duration of 5-6 years. 

 

So far that's a wash.

 

Now, come maturity on those bonds.... interest rates could be twice where they are today.  Hooray!!!  Now your interest income would be double the outflow.

 

So a way to play a potential rise in rates.

[CONeal]

Have been thinking about this for a couple of years and decided to pay cash when the time comes. 

 

The mathematical formalua I used to come to this decision was as follows....

 

Less stress, could be laid off without the fear of losing a place to live, might get a better price if someone is in financial stress, not guaranteed to continue making the returns as in the past, doesn't have to worry about payments and needing to pull money from the market when your stocks are in the toliet = a better nights sleep and takes out the possibility of sticking my neck out trying to hit a home run in the market when the cards are down.

[Philip Morris IV]

The way I see it:  if you borrow, you always have the periodic option to settle the loan with invested capital (especially if you allow for a conservatively-invested reserve).  Whereas if you pay cash for the house, I imagine this is a stickier decision to reverse.

 

You could also front-load the first few years and shave off years on the back-end, or just maintain a desired D/E ratio for your own comfort.  The point is, you have more flexibility and can be creative.

 

Disclosure:  not a homeowner or mortgagee.

 

Eric also makes a great point and I hadn't thought of it that way.  If these purchases are inevitable, risk tomorrow might as well = risk today.

[Guest]

From what I recall, in the Snowball, when Buffett bought his home in Omaha, he called it "Buffett's Folly'. Things still worked out okay for him though.  ;)

 

 

[xtreeq]

I think most people are irrational about buying a house and that makes sense because most people do not view it as a rational decision. I can tell you with certainty that my DW does not :)

 

However, I want to expand on Eric's line of thought. Basically, one would need extremely bad fortune to get into a position where one was unable to pay his mortgage:

 

1. Job loss and inability to find any job for an extended period of time; concurrently with

2. No cash on hand; concurrently with

3. Portfolio is significantly down; concurrently with

4. Housing is down and house cannot be sold for the value of the outstanding mortgage

 

The chances of all of these things happening together is pretty small, especially when you consider that number 2 is really something you control and you can always sell off some of the portfolio to keep a roof over your head

 

There are also several easy steps to minimize this:

 

1. Don't buy more house than you need [really this is what most people ignore so they end up with McMansions and must devise novel ways of heating their pool ... sorry Eric, I could not resist ;) ];

2. Keep part of your portfolio in cash + have 6 months' living expenses in cash (separately!) - this should ease the tension from problem number 1 and give time to sell the house

3. Have more than one salary in the household, which will lower number 1 again

 

As someone who has seen foreclosures from up close, what really gets 99% of people in trouble in the first place is overpaying and of those 99%, at least 90% could have bought less "house" ... so as the Romans said caveat emptor!

 

 

[ERICOPOLY]

 

1. Don't buy more house than you need [really this is what most people ignore so they end up with McMansions and must devise novel ways of heating their pool ... sorry Eric, I could not resist ;) ];

 

My house is a California bungalow -- actually it was built in 1912.  It is 2,300 sqft.

 

It has a tax assessed value of $2.7m.  Don't ask what a McMansion costs here!

[matjone]

The older I get the more I am thinking like you, no_free_lunch and CONeal.  Does it make any sense to take any chance of watching your family get booted out in the street, even if 99 times out 100 it works out in your favor?

 

My main objective is to avoid catastrophe.  Philip Morris IV brings up a good point too about flexibility too.

[Parsad]

Yeah, I think this is going to be one of those levels of comfort with risk answers, but I would probably take as much sub 4.5%, 30 year fixed, tax deductible debt as I could get...

 

I agree.  If you guys are in the U.S. and you can get below 4.5% over 30 years, with the deduction, then friggin' do it!  As long as you can afford to maintain that house and pay that mortgage from your investments, let alone any other earned income, it's a no-brainer.  Cheers!

[xtreeq]

I stand corrected Eric  8)

 

Though you surely realize your 1912 bugalow could buy you a McMansion in many locales!

 

[ERICOPOLY]

I would hardly consider it catastrophic if I invested my house money in BAC and it dropped down to $10.  Nobody would be booted to the street under that scenario. 

 

The $10 strike put only costs 47 cents.  You can raise the cash for those puts by selling the $17 strike covered calls on roughly 1/2 of your position.

 

Let's say your BAC shares escape Armageddon for a couple of years... as the stock rises you roll your puts to increasingly higher strikes.  Eventually you have 100% of your house money riding below the strike price.

 

I'm pointing out that "on the street" isn't even on the table.

[ERICOPOLY]

I stand corrected Eric  8)

 

Though you surely realize your 1912 bugalow could buy you a McMansion in many locales!

 

They don't have a 100 yr old date palm.

 

 

[merkhet]

 

Yeah, I think this is going to be one of those levels of comfort with risk answers, but I would probably take as much sub 4.5%, 30 year fixed, tax deductible debt as I could get...

 

 

I agree.  If you guys are in the U.S. and you can get below 4.5% over 30 years, with the deduction, then friggin' do it!  As long as you can afford to maintain that house and pay that mortgage from your investments, let alone any other earned income, it's a no-brainer.  Cheers!

 

 

Of course, this is assuming that you have to buy a house. I would think the opportunity cost of the down payment (20% of the house price) would likely be high for most of the posters on this board.

[Philip Morris IV]

The older I get the more I am thinking like you, no_free_lunch and CONeal.  Does it make any sense to take any chance of watching your family get booted out in the street, even if 99 times out 100 it works out in your favor?

 

My main objective is to avoid catastrophe.  Philip Morris IV brings up a good point too about flexibility too.

 

A big problem with the homeless-avoidance logic is that houses always entail a slew of non-mortgage sunk costs.  This makes having a paid-off mortgage an incomplete solution to the worst-case scenario.  It helps but is only one expense saved and at most, just buys time.  Property taxes, utilities, maintenance, etc. can just as easily force a house sale in hardship.  Whether you unlock the home equity to pay off a mortgage or just to survive, the result is the same.

 

In any case, I'm with xtreeq and Eric in the sense that the stars would have to be uniquely aligned to make someone with a decent investment portfolio homeless.  But combine that with an ineffective back up plan and it almost seems more risky to purchase a house in cash (assuming your opportunity cost is liquid investment capital).

[muscleman]

Do you use leverage in your investment? If you can't even get comfortable with a mortgage, I would be surprised that you use call options or even margins in your account.

[Guest]

I'd say it all depends on what's more important than you: maximizing wealth or minimizing your emotional strain.  There's not a right or wrong answer. It's all a personal decision.

 

Buying the home will reduce your emotional strains somewhat, but if you're draining half your portfolio to do it, that's a big wealth cost, too. Personally, I'd run the numbers and see if the cost, let's say 30 years from now, is worth it to have the peace of mind knowing that you and you're family are gonna have a rough over your heads even in a great depression scenario (assuming you can pay the taxes and whatnot!).

 

If you save and invest wisely, you should end up pretty wealthy one way or another.

 

Personally, I bought a home a while ago without a mortgage. It was a foreclosure so I looked at it as another investment. I figured it was a very low probably of loss and I should be be able to double (or maybe a bit more) of my original principle within 3-4 years and tax free to boot. The estimated profit had to do with a decent amount of rehab work and an improving housing market.  I bought it knowing that I didn't plan on living in it very long (no longer than 2-4 years). I didn't want to pay the mortgage closing costs and all of that. Could I have a bit more money now if I had taken out a mortgage. Yes, but if history ended up being different, who knows.  The bottom line is that there's not a right or wrong answer. If one's goal is to maximize wealth, buying it outright probably isn't the best move. If one's goal is to keep the Mrs. happy...well, sometimes that's worth something, too! :P  ;)

[ERICOPOLY]

Again, if you have puts to protect your investment portfolio then the "Great Depression" scenario is a 0% risk.  We should stop using that as a reason given that it's so easy to hedge against that.  It's just impossible, never going to happen.  You just buy your puts.  Simple, easy, we all can do it.

 

 

[ERICOPOLY]

What if you put all of this money into your house and then it burns to the ground?  Is the value of the structure lost?

 

Well, sure, if you don't have insurance.  Same with investments.

[muscleman]

What if you put all of this money into your house and then it burns to the ground?  Is the value of the structure lost?

 

Well, sure, if you don't have insurance.  Same with investments.

 

Sure. But let's compare the two scenarios:

1. Buying call options, or buying on margin and then buy put options as insurance, and then paying cash for a house.

2. Taking a mortgage for the house and then use no leverage in the stock market.

 

Which one is better?

He said his investment capital would be cut in half if he pays cash for the house.

So I think the above two cases are quite comparable, because buying on margin and buying put options roughly allows you to buy twice as you could without margin.

[DTEJD1997]

This is a hard call...

 

I am going to suggest there is more RISK to owning a house than what is commonly thought...

 

A). You are subject to the whims of your local municipality in regards to property taxes.  While this is probably a relatively low risk, I've seen some crazy things happen.

 

B). You are probably buying in a good area, but who is to say what it will be like in 10, 20, 30 years down the road?  I've seen some areas where property value is LESS than what it was 40 years ago.  And NO it is not limited to the inner city of Detroit.  While it is rare, this does happen in some places...

 

C). If things get really, really, really bad, do you think having a lot of capital tied up in a house is really the best idea?  What if you have to move?  What if property value collapse countrywide? 

 

D). What happens if you can't earn back the capital that you spend on the house?  What happens if you have a very nice house, but can't afford to maintain it, or property taxes, etc.

 

E).  A house is a very illiquid investment.  It could expensive and time consuming to get liquidity out of it.

 

F). If you have that much capital tied up, what about insurance?  Where I am currently living, insurance is VERY expensive.  In fact, it is sometimes so expensive, it can be a significant burden.  The person who bought a piece of property I used to own, was complaining that insurance was going up yet again.  I can't see it coming down.  Maybe your area is different, but it is something to consider.

 

If you are worried about not having a place to live, why not make a very significant down payment?  I just could not see paying cash for a house to live in if were 50% of my capital.  If it were 10% or 20%, maybe, but not 50% or more.

[Guest]

Again, if you have puts to protect your investment portfolio then the "Great Depression" scenario is a 0% risk.  We should stop using that as a reason given that it's so easy to hedge against that.  It's just impossible, never going to happen.  You just buy your puts.  Simple, easy, we all can do it.

 

To play devil's advocate, let's say one does that and there is a depression and the counterparty fails or something similar and now your puts are worthless. While I don't think that's very likely...well many didn't think the muni reset market would ever collapse back in 07 either.

[Kuhndan]

You can't go broke if you don't owe anything to anyone. Pay cash for the house and then work on your nest egg.