### paying for a house with cash.

If I have a million bucks, and live in an area where a pretty good house costs about $200K, would I just want to pay cash for a house? Or would I still want to finance it for some reason?

hi
January 17th, 2006

You might want to finance it, at say 5%, if you though you could put the money, say, in your company and make more than 5%.

Or you might just like the peace of mind of owning the house, free and clear.

Kasey
January 17th, 2006

Buy it. The advantage is that you're investing your principal capital in something that is extremely unlikely to lose value. Then with the money you earn from a job, you're free to do fun stuff like getting a dual 7800GTX SLI setup. Right Mat? :P

In the Netherlands you still finance it 100% as the interest costs are tax deductable.

There are some limitations but in general you can deduct the interest for a morgage from your pre tax income and get a refund.

This is under debate but any political party seriously suggesting abolishing it will for sure loses the next election as no home owner will like that very much.

Geert-Jan Thomas
January 17th, 2006

As opposed to buying it right away, and thus not paying any interest, and not needing to deduct tax from money you *haven't spent*???

Yeah I never understood that mindset of buying things or making huge donations for the tax deduction. Don't you have net more money if you DON'T spend it in the first place? How can the tax savings be greater than the donation/whatever?

Perhaps it means that the interest you get from sticking it in the bank is greater than the interest you pay on the mortgage. So, if you're sensible, you get a 100% mortgage, stick the money in the bank and retain the difference in interest between the two.

a cynic writes...
January 17th, 2006

"Perhaps it means that the interest you get from sticking it in the bank is greater than the interest you pay on the mortgage. So, if you're sensible, you get a 100% mortgage, stick the money in the bank and retain the difference in interest between the two."

Won't happen for the obvious reason that it's the bank that you get the mortgage money from. The bank actually lives off the difference between loan interest and savings interest, loaning out other people's savings. In reality these days savings interest barely covers inflation, whereas mortgage interest is calculated (here at least) as a fixed margin over the six-month average LIBOR/EURIBOR rate, which supposedly reflects inflation.

The savings interest might not be better than the morgage rate, but an investment return + the kicker of tax deduction might be.

Kasey
January 17th, 2006

You'll still get an investment return if you pay cash, and you'll still spend less money if you don't pay interest to begin with.

"You'll still get an investment return if you pay cash, and you'll still spend less money if you don't pay interest to begin with"

Look at it this way... you can take out a $200k mortgage where the interest you pay is tax deductable and invest the cash in an investment that returns at a rate greater then or equal to the interest paid on the mortgage, and end up ahead of just using all the money on the house. What you describe Flasher is safest, but a return on an investment is usually higher when the risk is greater.

This is half the reason businesses lease their computers and things instead of buying them outright. Sure, they are paying much more for a computer then if they bought it outright, but they used capital which could have brought a return elsewhere.

Phil
January 17th, 2006

GE,

In some cases, that $1000 that you give to the Salvation Army may in fact reduce your AGI to the point that you fall into a lower tax bracket. It could be a grand well spent.

January 17th, 2006

Kasey made my point better than I did.

It would depend on the mortgage rate, the investment return and (importantly) your income tax rate. I don't know what these are in the Netherlands but perhaps Gert-Jan will enlighten us...

a cynic writes...
January 17th, 2006

You don't invest with the people you lend from. You buy the house at the most advantageous rate, its value will inflate faster than the rate of the mortgage. The rest of your capital you spread around different investments.

"Yeah I never understood that mindset of buying things or making huge donations for the tax deduction. Don't you have net more money if you DON'T spend it in the first place? How can the tax savings be greater than the donation/whatever?"

It really only makes sense if you can lower your bracket.

(made up numbers)

If you would have to pay 30% of 70k, that ends up being 21k.

If you can lower your bracket to only pay 20% of 60k, that ends up being 12k.

Therefore, if you already have 3-4k of deductions, you only have to get rid of 6-7k to save quite a bit.

KC
January 17th, 2006

Numbers aside, own it. If you can afford it, owning something outright is, IMO, of far greater value that hiring. 'Value' being something extremely subjective.

As a general rule of thumb, less of it, more value. Of course, the legal and social ethos matters. Where I come from, and where I've been, fixed assets are held in much higher regard than current ones. Primarily because economic activity is predominantly focussed around the former. Where the population density is not very oppresive, it sort of makes makes sense to hold the other higher.

KayJay
January 17th, 2006

putting such a significant portion of your liquid assets into one place is kinda risky. what if property values don't increase at the rate expected? that's a ton of capital you could have earned more money on.

i'd put $100,000 into the house and borrow the rest. move the other $900,000 into a wide assortment of investments of varying risk and type...

Kenny
January 17th, 2006

KC (and anonymous)

You don't understand how tax brackets work.

If I have to pay 20% on 60K that is 12K. If I then have to pay 30% at 70K it would only be 30% for the extra 10K. My total tax bill would be 15K

NathanJ
January 17th, 2006

"putting such a significant portion of your liquid assets into one place is kinda risky. what if property values don't increase at the rate expected? that's a ton of capital you could have earned more money on."

Then again, they won't decrease, in fact even outside of a boom they will increase at the same rate as the economy, which tends to be more than inflation. Yes, you could make more money in other investments, but your money is safe and you don't have to make mortgage payments.

(Based on average earnings for reasonably safe investment funds, how much would you have to invest for your monthly profit to cover mortgage payments?)

Keep in mind, though, that there are some serious hurdles to jump through when buying a house for cash. For example, you need to be able to provide paperwork, etc, detailing the source of the funds. This is to, of course, ensure that you aren't some kind of "bad guy."

(I'm in the process of buying a house and this is according to my real estate agent.)

Jacob
January 17th, 2006

To prove you're not a terrorist, duh. :)

Warner's painfully detailed experience shows us that buying a house on a mortgage isn't a walk in the park either.

"Then again, they won't decrease, in fact even outside of a boom they will increase at the same rate as the economy, which tends to be more than inflation."

Past results do not equal future returns. Yes, "traditionally" this is the case, but for example in the overinflated DC housing market there are many homes that would probably go down considerably in value if the real estate bubble bursts (as it did in Boston and LA in the early 90s). Go look at some of the homes in Bolton Hill, Baltimore for an example of homes losing value dramatically. Not to mention things outside of your control, like say a highway ran through your backyard (ICC in Maryland), a terrorist attack (downtown manhattans prices fell sharply) etc...

Phil
January 17th, 2006

Well yes, but that sort of falls under the "shit happens" category. :)

I wonder if anyone offers insurance against sudden drops in value.

With $200k, you could buy one house with cash, or put 20% down on each of five houses and rent out four of them. Generally, if you're careful, the rental payments will cover the mortgage payments, so you're getting five houses for the price of one.

The mortgage interest deduction means you're not paying income taxes on the rent.

Philo

Philo
January 17th, 2006

With $200K and God's credit rating.

:)

Depends where you are...round here they're happy to lend moer or less anyone 80% at a higher interest rate. It's called a buy-to-let mortgage and is stunningly popular on the manor squire.

a cynic writes...
January 17th, 2006

I think what it comes down to is running the numbers on your specific income info. Spend the couple hundred bucks on a tax accountant (if you have a million bucks you already have a tax accountant, right?).

In the meanwhile, let's run some hypotheticals. The interest on a 6% mortgage for $200K is going to be a little less than $12K ($11.9K for 30 year, $11.6K for 15 year). Let's say a 30 year mortgage.

Let's assume you make $100K a year in a regular job (if someone knows a region where a senior programmer can make $100K and buy a house for $200K, email me right now!!). That puts you well into the 28% bracket. So deducting $11.93K from your income still leaves you in the 28% bracket and means you can pay 0.28 * $11.93K = $3340 less in taxes. Which means you're really paying $8.6K in interest on the $200K in the first year.

The central question is: is there somewhere you can invest $200K **RISK-FREE** and make enough to, at least, cover the $8.6K. That means a rate of 4.3%. The most risk-free you can get is a US Treasury bond. A 30-year US Treasury bill today is at 4.55% which means you can lock in the interest you receive over a period matching the original mortgage. By getting a mortgage you can earn an 4.55% * $200K = $8.65K. Hey that's $50 more! You have to pay federal taxes on that income, which would be $8.65 * 0.28 = $2400. So getting a mortgage will cost you $2350 the first year. You will really need to make $8.6K / (1 - 0.28) = 12K or the original 6% mortgage rate!

Of course, you can try other investment vehicles - bonds, stocks, mutual funds, hedge funds, your own business, casinos - but the guarantee on return in any of these can't match the guranteed interest the bank will be charging you on your mortgage.

Let's say you're retired and are collecting $40K in capital gains/Social Security, then you're effective tax bracket will be like 15%. You can only deduct $1800 and so you still need to pay $10.1K in interest. That's a 5.05% rate. No T-Bill is paying that high right now so to recoup the interest you have to take a higher gamble.

If you're making $350K a year (well into the highest federal tax bracket of 35%), you'd need only 3.8% return on a riskless investment to justify paying cash. That's why rich people have mortgages.

These rates are for federal taxes. Factor in state taxes (or if you live in a higher taxed Europe) and you'll find it makes sense to pay cash under a certain amount, and to take out a mortgage above that amount.

This is a fairly easy exercise for a good tax accuntant (I only had the interest worksheets lying around as I helped my sister figure mortgage stuff).

Spinoza
January 17th, 2006

Of course house prices are not guaranteed to go up. My sister just emailed me that the $620K 2-bedroom condo I looked at with her during Thanksgiving can be taken now for $530K.

Spinoza
January 17th, 2006

In the US, you can deduct the interest payments on the mortgage from your income. This reduces the effective interest rate of the loan. This effective rate depends on your tax bracket.

Compute this effective rate and compare it to a low risk investment rate.

At the moment, mortgages are about 6% and you can get about 4% on a savings account (eg ING). If we assome you are in a 25% bracket, the effective rate of a 6% mortgage is 4.5%.

Note that the rate of return on safe investments will likely increase and the rate of the mortgage is fixed.

You should probably finance the house.

somebody else
January 17th, 2006

"If I have to pay 20% on 60K that is 12K. If I then have to pay 30% at 70K it would only be 30% for the extra 10K. My total tax bill would be 15K"

Unless you get hit by the AMT... where I had already donated 15% of my income to various charities and then STILL had to pay at the end of the year on top of my withholding.

KC
January 17th, 2006

>> Of course house prices are not guaranteed to go up. My sister just emailed me that the $620K 2-bedroom condo I looked at with her during Thanksgiving can be taken now for $530K.

Your logic is flawed. The fact that the asking price went down from 620K to 530K doesn't mean that the real estate values went down. It could have been overpriced at 620K. Now, if you said that someone bought it at 620K and then (2 months later!) sold it at 530K, it might make more sense. However, if you resold 2 months later, your emergency situation would probably require you to take a loss.

GML
January 17th, 2006

Yes, GML, since no one bought that particular condo there was no mutually agreed upon (by both seller and buyer) price. But there was an expectation of price on the seller's side. The expectation was buoyed by the selling of nearly identical units in the same building for $600K+ this past summer. The expectation has fallen (in the hot market condos often sell *above* asking price).

Spinoza
January 17th, 2006