#RealEstate: Difference between paying for a house in #cash and getting a #mortgage


For wealthy people, the main question when buying a home is often whether to mortgage it. If you’re sitting on a large sum of cash or liquid assets, you can choose whether to pay for the house outright, or just use cash for the down payment and take a mortgage out on the home.

Let’s look at two scenarios for a 35-year-old couple, Marc and Melinda, buying a $1 million home. In the first scenario, they purchase it outright for $1 million. In the second, they put down 20%, or $200,000, and take out a 30-year fixed-rate mortgage at 4.3% for the remaining $800,000.

Which strategy would add most to the couple’s target financial capital—the wealth they need to support themselves when they stop working? They’d like to spend $200,000 a year, inflation-adjusted, beginning at age 65.

The results may be surprising. Whether they purchase the home outright, or take out a 30-year mortgage, we estimate that their target-financial capital requirement would be the same: about $4 million, in typical markets.

That’s because the benefit of eliminating monthly after-tax mortgage payments would be offset by the investment returns forgone over decades, if the money to buy the home comes from their target financial capital.

From a target-financial-capital perspective, Marc and Melinda should be indifferent. Whether to mortgage is less a financial decision than an emotional decision for them: Would they simply feel better if they had less debt? If so, they should probably consider first paying off any higher-cost debt they have.

In our view, the best way to think about a mortgage is in terms of how it affects your overall asset allocation. If you own your home outright, you may have too large a portion of your net worth exposed to residential real estate, which can be risky in the short run.

A mortgage enables you to diversify, by retaining or increasing your exposure to financial assets that provide either stability or growth opportunities to your overall wealth.

For entrepreneurs, taking out a home mortgage has another benefit: It may preserve liquidity, perhaps to fund a new venture. If you don’t take out a mortgage to buy your house, you’ll probably be able to mortgage it later if you need cash—albeit at potentially higher rates. The rules regarding tax-deductibility are also somewhat different in these circumstances.


Strategic Support Department

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