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Do I Make a Cash Purchase or Finance My Home?

Cash Home

Cash Purchase or Finance?

Orange County, CA – Approximately 30% of homes purchased in Orange County in 2012 were bought with cash. On the face of it, the question within the title really does seem strange at first. If you have enough money in the bank the answer for many is a blinding yes! However, take a few minutes to analyze your situation, and you might just change your mind about a cash purchase.

Cheap Money

Money is really cheap at the moment. As of December 13th, 2012 the average 30 year fixed rate, according to Freddie Mac’s weekly survey was 3.32%. That’s a hair, 0.01%, above the historic low reached on November 21st, 2012. Savvy investors and well-to-do homeowners, realize that it takes money to make money. Therefore a cash purchase may not be favourable. For many, it’s more advantageous to keep their cash liquid and borrow from the bank. They can lock in a low interest rate for up to 30 years, then put their money to work over the same period of time.

A rising tide lifts all ships! Therefore, if interest rates increase over the years, as is expected, then so should your return on investment. However, your monthly mortgage payment will remain cheap at the fixed rate you lock in today. Ultimately your yield will increase as the spread grows between future interest rates and current interest rates. In this example a cash purchase is less valuable.

Rate of Return

When deciding whether to finance or make a cash purchase, another area of consideration is the overall rate of return on your investments. Do you invest in your home or invest elsewhere? What are the tax implications of each? What about inflation costs and lost opportunity costs? These are some of the variables that one needs to consider with such a large amount of money at stake.

Keeping a mortgage on the home does provide tax write offs that are not available when paying cash. The largest of these is the annual mortgage interest deduction. The interest deduction alone can add up to thousands of dollars saved every year.

Inflation needs to be considered as well. As I write this article, a local bank is advertising a 1 year CD with interest offered at 0.29%. And if you lock up your money for 10 years, they’ll bump that up to 1.10%. That’s a paltry sum of interest. If you opt to invest in CD’s you’re actually guaranteed to lose money over time. That’s because the current rate of inflation, is 1.76%. Prices are increasing faster than your money can grow! The loss is even greater when you factor in the taxes paid on the interest your earned. So if you can’t invest your money with a return that’s greater than 3.50%, you may want to finance your home purchase.

Finally, there are the opportunity costs of the money. Your dollars can’t work two jobs. If you invest a dollar in your home you can’t invest the same dollar in a new business or a mutual fund. As I mentioned above, when interest rates rise over the years so too will the returns offered to investors with capital. So, a cash purchase of a home has long term financial implications. You won’t have a monthly payment, so you can begin re-building your savings. But if a lucrative opportunity presents itself and requires a significant cash infusion, you may be stuck on the sidelines.

There are times when paying cash is a no-brainer. And there are times when it does not. If you do decide to make a cash purchase, you can always pull your cash back out later. Some homeowners do this to improve their bargaining power with a seller. Others do it to buy foreclosed properties at the county courthouse auction. In those cases, we can help you pull your funds back out in less than 6 months with the delayed financing exception.

Clearly both options have pro’s and con’s. Either way, it’s important to take into consideration all the variables before making a decision. Only you know what your present and future looks like. But meeting with a financial planner and loan officer can help tremendously. They will help you plot a financial course that’s best for you.

If you’re looking for a loan officer to help you with your plan, please contact me. You and I will develop a plan together and determine if you should make a cash purchase or finance.

Scott Storace

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