At a time when many Americans would find it difficult to scrape up even a 10% down payment for a home, a surprising new trend has emerged. Increasing numbers of home sales are now all-cash deals, but is paying all-cash fr your next home wise, Here is some pros and cons, why you should and shouldn’t.
According to data supplier RealtyTrac, 38.1% of residential property sales in the U.S. in November 2015 were all-cash arrangements, up from 30.9 percent a year ago to the highest level since March 2013. RealtyTrac suspects the increase in all-cash sales is due to the new documentation and disclosure rules for mortgages that took effect in October of last year and global instability that drives foreign cash buyers to the relatively safe U.S. real estate market.
So if you’re in the market for a property, either as an investment or as a residence, and could afford to pay cash for it, should you? Here’s a look at some of the pros and cons.
Why All-Cash Makes Sense
1. A seller who knows that you don’t plan to apply for a mortgage is likely to take you more seriously. The mortgage process can be time-consuming, and there’s always the possibility that an applicant will be turned down, the deal will fall through and the seller will have to start all over again. Being ready to pay cash not only gives you an edge with motivated sellers eager to close the deal, it also helps with sellers in real-estate markets where inventory is tight and bidders may be competing for their property.
2,You could get a better deal. Just as cash makes you a more appealing buyer, it also puts you in a better position to bargain. Even sellers will understand intuitively that the sooner they receive their money, the sooner they can invest or make other use of it.
3. You don’t have to endure the hassle of getting a mortgage. Since the housing bubble and ensuing financial crisis of 2007-08, mortgage underwriters have tightened their standards for deciding who’s worthy of a loan. As a result, they are likely to request more documentation even from buyers with solid incomes and impeccable credit records. While that might be a prudent step on the part of the lending industry, it can mean more time and aggravation for mortgage applicants. Sometimes buyers couldn’t get a mortgage because they already have an existing mortgage on another house up for sale, so they use cash to purchase the new property. When the other property sells, they can take that cash or they may then place a mortgage on the new property unless they want to forgo the interest.
4. By paying all-cash, you don’t have to worry about mortgage. Mortgages usually is the largest single bill most people have to pay each month, as well as the biggest burden if income falls off due to job loss or some other misfortune. In this day and age very few people ever pay off their homes, because they are financed for 15 to 30 years. They are usually selling for a new home or refinancing to remodel. If peace of mind is important to you, paying off your mortgage early or paying cash for your home in the first place can be a smart move. That’s especially true as you approach retirement. Though considerably more Americans of retirement age carry housing debt than was the case 20 years ago, according to Federal Reserve data, many financial planners see at least a psychological benefit in retiring debt-free. It is wise when downsizing to a less-expensive home in retirement, to use the equity in their current home and not get a mortgage on the new house.
What You Lose
1. You’ll be tying up a lot of money in one asset class. If the cash required to buy a home outright represents most of your savings, going against the rules of personal finance: diversification. What’s more, in terms of return on investment, residential real estate has historically lagged well behind stocks, according to many studies. That’s why most financial planners will tell you to think of your home as a place to live rather than an investment. The only investment real estate can be is in short term such as flipping: buying, remodeling and reselling.
2. You’ll lose the financial leverage a mortgage provides. When you buy an asset with borrowed money, your potential return is higher – assuming the asset increases in value. For example, suppose you bought a $300,000 home that has since risen in value by $100,000 and is now worth $400,000. If you had paid cash for the home, your return would be 33% (a $100,000 gain on your $300,000). But if you had put 20% down and borrowed the remaining 80%, your return would be 166% (a $100,000 gain on your $60,000 down payment). This oversimplified example ignores mortgage payments, tax and other factors. Another advantage is a deduction for taxes of your interest and closing costs.
It’s worth noting that leverage works in the other direction, too. If your home declines in value, you can lose more, on a percentage basis, if you have a mortgage than if you had paid cash. That may not matter if you intend to stay in the home, but if you need to move, you could find yourself owing your lender more money than you can collect from the sale.
3. You’ll sacrifice liquidity. Liquidity refers to how quickly you can get your cash out of an investment if you ever need to. Most types of bank accounts are totally liquid, meaning that you can obtain cash almost instantly. Mutual funds and brokerage accounts can take a little longer, but not much. A home, however, can easily require months to sell.
You can, of course, borrow against the equity in your home, through a home-equity loan, line of credit or reverse mortgage. All of these options have drawbacks, including fees and borrowing limits, so they aren’t to be entered into casually.
The Bottom Line
Paying all cash for a home can make sense for some people and in some real-estate markets, but make sure you consider the downsides too.