3 Reasons Buying a House in Cash May Be a Bad Idea -- Even if You Can Afford It
You could hurt your efforts to build your net worth.
- Buying a home in cash may seem advisable if you can afford it since you can avoid paying mortgage interest.
- Unfortunately, a home is a very illiquid investment and you'll be tying up a lot of money.
- You'll also limit your ROI, which could come at a huge opportunity cost.
If you have the cash to buy a home, it's probably tempting to just pay for the property outright rather than dealing with a mortgage lender. Although this may seem like a good idea on the surface since you can avoid the hassle of applying for a loan and can save on interest, the reality is that it's probably not the right financial move in most situations.
So, why wouldn't you want to buy a house in cash if you have the money? Here are three big reasons.
1. You could miss out on a better ROI
If you pay for a house with cash instead of taking out a mortgage, the return on the big investment you made is limited to the mortgage interest you saved. Since mortgage rates are around 5% for a 30-year fixed-rate mortgage, and have been much lower in recent years, your ROI is limited.
Investing in an index fund that tracks the S&P 500 is likely to produce average annual returns of roughly 10% over time based on historic performance -- and you'd be taking on somewhat limited risk with this investment (compared to a single stock) due to the fact you'd own a small stake in around 500 of the largest companies in the United States.
By comparing the ROI from avoiding a mortgage versus investing in other things, it's easy to see the huge opportunity cost associated with paying cash for a home. If you have a finite amount of money, tying so much of it up in a home instead of investing it could really limit your ability to build wealth. This could leave you with a smaller net worth and with a lot of regrets.
2. You'll be tying up a lot of money in an illiquid investment
When you pay cash for a house, you're tying up hundreds of thousands of dollars in an investment that can be time consuming and expensive to sell. This could pose a big problem if you need quick access to your money.
Sure, you could always take out a mortgage on your home later -- but this takes time and money for closing costs which you may not have if you face an emergency.
Rather than tying up so much of your money in an illiquid investment, you may be far better off getting a mortgage and keeping more cash in savings and the stock market where it can be accessed more easily without huge fees.
3. You'll miss out on potential tax breaks
Finally, if you forgo taking out a mortgage, you'll pass up the mortgage interest deduction that's available to you on mortgages up to $750,000 if you itemize your tax return. This deduction is a valuable one, and it allows you to get a government subsidy that helps you afford your home.
For all of these reasons, most people are far better off borrowing to buy a home after making a reasonable down payment. It's what billionaires including Mark Zuckerberg and Warren Buffett have done, so you may very well want to follow their lead.
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