Wednesday, May 2, 2007

Take out a mortgage, or pay all cash for a house?

Jack Guttentag has a great article at Yahoo Finance answering a reader question about purchasing a home. Should you pay cash for your home? First of all, you son-of-a-gun, if you can pay cash for a house, you're a richer man than I am!

The math is simple - proceed to the article for a specific example with numbers. The long and short of it is that if you earn a rate of return on your investments greater than your mortgage rate, taking out a mortgage leaves you better off in the long run. The mortgage on my main residence is at 5.5%, so I do believe I would have to make some pretty horrible investing decisions to not beat that percentage. Therefore, I borrowed.

Mr. Guttentag also offers some deeper advice, which I completely agree with. Assume you want to pay cash for your house, and you want to see how much more or less money you'll have in 15 years. The example assumes that, if you pay cash for your house, you save and invest exactly the amount of money you would have paid in a monthly mortgage payment.

But, would you really do that? Many people prepay on their mortgages, or pay cash for a house, because they want to feel free. I have to admit - I really look forward to the day I make that last payment on our house (and on our lakehouse, and on our apartment building... ... Sheesh!). It's going to feel like Christmas time when that mortgage is gone! Imagine you feel this way as a young person in your 20's or 30's. You might feel rich, and you might consequently act that way, spending money in ways that you wouldn't have had you had a mortgage hanging over your head.

It seems counterintuitive to some people that borrowing is good, but in this case, you should be able to consistently earn a rate of return on your investments greater than the interest rate on your mortgage. So I think it makes sense to borrow, and leave your nest egg intact.


plonkee said...

If you can afford to buy a house for cash you certainly have fewer problems with money than most.

Mr. Cheap said...

For Canadians our mortgage payments aren't tax deductible (for primary residences at least, they are for rental properties), so that changes the equation somewhat for us.