And why would it ever be a good idea to borrow if you can pay cash and pay no interest to the bank?
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Follow up question, how do rich people save money on buying a house by borrowing vs paying cash?
Just do the math, right now a 500k loan would cost at 3.7k a month. Let’s round up to 4k. This is using todays rates.
500k in the S&P returns 9.59% over the past 30 years. Roughly 48k per year. And after 1 year your tax on that is 0%.
20% on the 48k is 9.6k in taxes due in the first year only.
Interest payments the first year is 33k. Let’s say your top income bracket is 24% that reduces your tax liability by 8.2k.
You home owners insurance and PMI is also tax deductible which is about 3.5k equaling 800 is reduced tax liability.
So basically your first year out of pocket is $600
This is using the average return which of course is never guaranteed.
But at the end of 30 years with a loan you have a house and 500k in the market.
Without a loan you have a house still but it still cost you $3600 a year for insurance and taxes, possibly more. And no money in the bank.
Or even simpler, 500k in the market is going to be 8.5 million after 30 years.
The cost of a loan for a 500k house over 30 years is 1.3 million but probably closer to 1.5 including insurance and tax increases. And this doesn’t include refi down to a lower rate when rates are good.
I had to put 20% on my house 2 years ago. It is a 500k house. My loan amount was 380k and my payment is 1850 a month.
The market is where you want your money. Not a house.
It should be noted that the interest rates usually offered for mortgages are very low compared to other types of loans and are not usually that far above inflation, so I’m not even going to address interest rates.
Pros for Borrowing:
* You can afford houses that you could never realistically hope to save up cash for before the age of, like, 60. This is the main benefit for middle class buyers, since people usually like to own a home sometime before the age of 60.
* Rich people can deduct mortgage interest on their taxes.
* Rich people can take out a low-interest mortgage and use their house(s) as a giant low-interest credit card so they don’t have to sell stocks for cash. >!Since rich people like to use their political power to make sure that real estate prices always go up, the effective interest rate might actually be negative.!<
Cons for Borrowing:
* The bank has a lot of control over the purchasing process, which they can delay or cancel for reasons you might not agree with. You can’t buy as quickly as with cash due to all of the red tape.
* The bank will force you to get insurance, an inspection, etc. because the home is your collateral, and they don’t want anything to happen to it.
* You can get denied a loan if you don’t have a good credit score or a “traditional” 9-5 job.
* Fees.
TL;DR: Mortgages are really attractive loans, and even some billionaires take them out so they they can use the money elsewhere. Having a lender involved in the purchasing process decreases your flexibility, though, since you need the bank’s permission to do anything.
I paid cash for my current car. It was “only” $27,000, and it hurt to let go of such a big chunk all at once. But I was unemployed, I had that much cash available, and I didn’t want to have a bill hanging over my head for the next 5 years or pay the bank a bunch of extra money because of the interest I owed them. In that situation, paying a single lump sum made the most sense to me.
For every other car (and house) I’ve owned, I paid in installments over years. Though I do try to pay early and cut down the amount of interest I have to pay… I paid off my 30-year mortgage in 21 years.
Also have to consider the alternative; renting. You need to have housing.
Any money you pay in rent is gone, any money you pay into a mortgage is eventually going to be your property. The only time renting is beneficial over buying and paying of a mortgage is if you aren’t expecting to stay for long and if you’re losing opportunity costs (ie, putting that down payment somewhere else with potentially better returns).
Even if you had the cash to buy a house immediately, I’d still consider getting a mortgage, if not just for the additional financial buffer, comfort of living and investing the remainder.
If you have the cash to buy the house, it’s best to buy it and then get a HELOC, then use the money from the HELOC to invest in the stock market. You get a better interest rate that way, and at least in Canada it’s tax-advantaged (you can deduce your HELOC interest from your taxes, but you aren’t allowed to do that for a mortgage for a personal home).
If it were a given that you could easily better the bank’s interest rate with the return on any investment you might make… then why is the bank lending you the money? I promise that the bank is smarter about money than you are and their best idea is to lend it to you.
Why do you want more dependents? Why are you sharing your money with all of the employees and investors at the bank?
Also, every twenty years or so there is a major recession. Pay off your loan ASAP!
Then sell your house, realize all of the profit and buy something nicer. Repeat.
Don’t fall for the “tax deduction” scam. It’s just the icing on a shitbuger idea.
First you would have to have that money at hand. But then the question becomes, what else could you do with it other than buying a house? Realistically, if you have enough wealth to buy a house outright, you have it invested somewhere. Buying a house is just a different sort of investment. So you would have to consider, is it a better investment and is it worth the reduction in diversification. Maybe the rates you could get from a bank aren’t so bad after all?
Well, the question becomes, what are you buying the house for? If it’s your home, it’s very hard to beat that investment. If it’s a property you intend to rent out though, that’s not so clear cut case anymore at all.
Paying cash can save a lot of interest, and is usually cheaper in the long run (but not always, depending on inflation, house prices and interest rates). It also means you will immediately own the property outright and you can’t be ousted by the mortgage provider in the event you cannot meet your mortgage payment obligations.
The main advantage of borrowing is that it enables someone to buy in the first place, as property prices are usually prohibitively expensive without a mortgage or loan.
It used to be you’d get tax credits for the interest payments, so if you earned $40k/yr and paid $20k/yr on interest, it was like you earned $20k/yr for taxes. But Trump limited that to a maximum of $10k/yr for interest deductions, so you don’t want your interest payments on your loan to exceed $10k/yr.
There are great online “mortgage amortization” calculators which show you payment numbers. The goals are to keep cash on hand for emergencies like earthquake damage or flooding damage so you won’t lose your house. Most insurance plans don’t cover these for a reasonable cost so unless you are in a known area, most people opt out of coverage. Since cars don’t get a tax deduction for interest, paying cash for a car beats paying cash for a house. Also, credit cards charge even higher rates, so pay off your credit cards first, then your car, then your house.
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