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All-cash offers for homes are available all the rage lately, but is it as good an idea as most of us think? While making an attractive offer to the seller, consider the ramifications of tying up your money with an asset like home, as you could make more money in the long run by taking out a mortgage and plowing some of that money into a mutual fund.
Why cash isn’t always king when it comes to real estate
At first glance, it seems so simple: if you buy a home with cash outright, you don’t have to go into debt with a mortgage. Finally, you’d avoid spending $ 129,444 in. to pay Interest alone, for a $ 250,000 mortgage that requires 3% interest over 30 years. Who wanna do that?
Well, the problem is the opportunity cost: if you put most of that money in a mutual fund, the return would exceed the additional interest you would pay on the interest, especially since mortgage rates are so low. For the past 30 years, the S&P 500 index has been one average annual growth rate of 10.7% per yearwhile the mortgage rates are much lower. The average 30-year fixed-rate mortgage is currently 2.84%, the average rate of the 15-year fixed-rate mortgage is 2.24%. Investopedia has a great example of how this works:
For example, suppose you bought a $ 300,000 home that has increased in value by $ 100,000 since then and is now worth $ 400,000. If you paid for the house in cash, your return would be 33% (a profit of $ 100,000 versus your $ 300,000). However, if you deposited 20% and borrowed the remaining 80%, your return would be 166% (a profit of $ 100,000 for your down payment of $ 60,000). This oversimplified example ignores mortgage payments, tax deductions, and other factors, but that’s a general principle.
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And if you split that money up, you can benefit from two types of investments, rather than just one. That means that in addition to your property, you could have an index fund with an annualized return of 10% whose average annual return can be anywhere from 5% to 15%. In that sense, paying 3% on a mortgage, for example, isn’t that big of a deal. Because of this, wealthy people strategically take out a mortgage for leverage, even though they could always pay off the loan.
Of course, reservations apply. Investing in both real estate and stocks carries some risk, as past performance is no guarantee of future results. And everyone’s financial situation is different. One of the benefits of owning a property with no funding is that you don’t have to deal with monthly mortgage payments that are a strain on your budget. Plus, sometimes you just need a home, and in this sellers’ market, cash is sometimes really king.
Bottom line
Consider consulting a financial advisor before making any major investment, including a cash home purchase. A house is a great asset, but it is not easy to turn it back into cash when you need it, and you can better use some of that money for other investments.
