Why is it better to buy a home with a mortgage even if you can buy it off in full?
In: Economics
Depends on your interest rate, the time you plan to hold onto the home, and what you could do with the cash if you don’t spend it on a house.
Let’s take an easy example – $100K house, you have $100K+ in cash you could use to purchase the house outright, you plan to hold the house for 5-10 years.
So if you spend $100K on the house, that’s that. All $100K is tied up in the house. If you sell in 5-10 years for $150K, you made $50K on a $100K investment. 50% – that’s not bad. But if you put down $20K and financed $80K when you first bought, then when you sold, you made $50K on a $20K investment, a 250% return. This ignores your borrowing costs for the moment, but even if you assume you pay $20K in borrowing costs, you still end up making $30K on a $20K investment, or a 150% return. You can calculate all of this precisely based on particular rates and terms, but these examples should give you an idea of why it’s often a good idea to use other people’s money when paying for your stuff that you can resell later. It’s called leverage, and it’s an extremely powerful tool for taking modest returns and making them much higher. There’s risk with leverage of course, but if you have the cash at the outset, your risk is small so long as you don’t lose it.
Leaving that aside, if you can borrow money for significantly less than what you can (more or less) safely earn on it, it’s a good idea to borrow that money as long as you actually invest the cash you didn’t need to use on the house. You need to know your likely rate of return and what your taxes will look like to determine how valuable this approach is, but generally speaking the lower your interest rate, the more attractive this option becomes.
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