Buy House with Cash OR Mortgage and invest

[ThisTooShallPass]

I searched and read quite a bit on this topic, however, I really appreciate the wise minds to look at my situation and provide some insight that puts me in the right direction.  I truly respect this forum's collective wisdom.

In less than 6 months I plan to Retire Early from my job. Wondering if it is better to buy a house 100% cash or go for mortgage (20% down).

Excellent credit rating, 15 year APY @ 3% and 30 years at 3.8%

$400k comes out of the taxable savings account earning 2.35%. 

Age: 44, Married with two children

Currently Renting. Relatively closer to work. High cost of living area with the highest property tax in the country.

Planning to buy a house in low cost state but not too from where I live so current friends are “accessible”.   
Brand new house priced at $400k (2,300 Sq. Ft. , already factored in for some upgrades like bigger lot for vegetable garden, moving costs and certain one time costs).

Expenses at early retirement would be $25k but we are flexible both ways.
The magic number $625k (using 4% rule of thumb) is in taxable accounts (30% tax managed muni bond index, 70% stocks index for now but will transition to ~90% to stocks over time)

ROTH, IRA’s are in good shape (don’t like to touch this for another 15-20 years, however, may take out some money from ROTH early for children’s collage in few years.

If I go for the mortgage this $400k will be dollar cost averaged into the markets (more like 80 or 90 stock index rest bond index)

Thank you, let me know if any additional information is required.

[RWD]

Investment Order

Take the mortgage.

[GoCubsGo]

How are you getting health insurance?  Would having a mortgage impact ACA income thresholds (I don't have a lot of knowledge of ACA costs but I've seen it discussed in regards to having a mortgage or not).  $25k for a family of 4 with a home to take care of seems super low.  Does your spouse plan on continuing work?

[Roots&Wings]

How are your expenses the same $25k if you pay cash outright vs mortgage and invest?

Usually this would result in different expenditures, with the mortgage expense having a fixed time horizon but requiring additional monthly capital to pay (with the lump sum invested in the market to grow at a higher rate of return than the mortgage interest rate vs paying cash outright).

However, the source of the income to pay the ongoing mortgage expense could potentially impact income thresholds for health insurance as GoCubsGo noted. Plus, some people prefer not having the ongoing mortgage expense in case of market downturns.

What bank is paying 2.35% interest rate on $400k?

[SuperSecretName]

Is spouse working?

A mortgage in early retirement increases sequence of return risks.  That doesn't mean you should pay cash for the house, just something to consider.

You don't provide your full picture, so hard to recommend either way. 

You undoubtedly know the math that says investing is better.  It will be an emotional choice for you.

[ThisTooShallPass]

How are you getting health insurance?  Would having a mortgage impact ACA income thresholds (I don't have a lot of knowledge of ACA costs but I've seen it discussed in regards to having a mortgage or not).  $25k for a family of 4 with a home to take care of seems super low.  Does your spouse plan on continuing work?

Current health insurance is through employer, I switched to HSA for 2020, have a small premium.
I am tracking way below than $25k for past several years besides rental and other work related expenses. For the new scenario, I added property tax ( 0.56% is effective property tax rate in DE), about $1,000 in home maintenance (since it would be a brand new house, hopefully I can get by $1000/year average for short to mid-term).  First year home maintenance will be high but have budgeted in.   ACA is being the tricky part - will $400 / month be enough?. 
My wife is a homemaker.

[ThisTooShallPass]

How are your expenses the same $25k if you pay cash outright vs mortgage and invest?

Usually this would result in different expenditures, with the mortgage expense having a fixed time horizon but requiring additional monthly capital to pay (with the lump sum invested in the market to grow at a higher rate of return than the mortgage interest rate vs paying cash outright).

However, the source of the income to pay the ongoing mortgage expense could potentially impact income thresholds for health insurance as GoCubsGo noted. Plus, some people prefer not having the ongoing mortgage expense in case of market downturns.

What bank is paying 2.35% interest rate on $400k?

Expense doesn't include mortgage payment but everything else.  I need to determine if it would be wise to invest $400k or take a mortgage.

Very good point made by GoCubsGo.  My understanding is using the 2019 tax rules, a married couple can earn up to ~$24,400 /year without paying tax because of standard deduction. Other deductions like 401(k) contributions reduce taxable income. Once income and spending level exceed this level taxes must be paid, unless that income comes from qualified dividends or long term capital gains, which means $24,400 a year income PLUS ~$78,750 in investment income. So basically if income and spending are below these levels then we can avoid capital gains.   How do I confirm of this impacts ACA income threshold? thoughts?

Marcus by Goldman Sachs had a No-penalty CD @ 2.35% in 2019 and I signed up. It is lower for new members now.

[ThisTooShallPass]

Is spouse working?

No

A mortgage in early retirement increases sequence of return risks.  That doesn't mean you should pay cash for the house, just something to consider.

You don't provide your full picture, so hard to recommend either way. 

Did I miss any critical info? happy to provide

You undoubtedly know the math that says investing is better.  It will be an emotional choice for you.

Agree but trying to gain perspective if someone has gone through this situation (retire early, take mortgage and ACA) 

[ReadyOrNot]

Is $400k for a house considered low cost area?  Mine is close to that but I consider mine low to medium cost area.

I think you will be fine either way.  However, having a mortgage gives you additional flexibility that you may not have other wise.

Preserving that cash to grow in the market or in a high yield savings vehicle counter balances out the mortgage for the most part.

And in case of extreme market meltdown, you can potentially short-sell the house (if you had to move for some reason) and share the losses with the bank, as many people did during 2008-2012 recession. 

If you don't need the cash short term (less than 3-5 years), you will be ahead by investing it as well.

Mortgage and owning a house are both hedges against inflation.  Mortgage guarantees your housing costs compared to renting, and house gives you long term place to reside without worrying about landlord selling your rental.

[JSMustachian]

If you plan on doing a mortgage I would do some estimates on healthcare.gov if you plan to use the ACA to make sure you are comfortable with what you see. The increased monthly cost of a mortgage increases the amount of income needed therefore less cost sharing subsidies and premium tax credits.

[Lucky13]

One thing to consider is if you quit your job it will be harder to get a loan (although it's possible as others on this board have explained), but if you take a mortgage now, you can always pay it off.  OTOH, "paying cash" may be an advantage in buying a new place, for example if there are multiple offers on a property, the seller might accept the all-cash one since it's quicker to close. (this might not be true in your region)

[frugaliknowit]

I would ABSOLUTELY pay cash for the house if retiring.  Taking out a mortgage establishes a HUGE sequence of returns risk.  You will be retired.  You will have sequence of returns risk even without the mortgage!

[seattlecyclone]

I'm a big fan of taking out the largest low-rate mortgage possible while in the accumulation phase. Investing other people's money in this manner tends to be a pretty sweet deal. For our first house we paid off the mortgage as fast as possible rather than investing our surplus cash, a decision that in hindsight cost us around $100k toward our net worth at the time we sold it in 2017. When upgrading to our current house we took equity off the table and took out a pretty sizable mortgage rather than selling stock to pay cash for the house. In less than three years I think we're up at least $100k on that decision.

During retirement it's a bit of a different story. If you're taking income from mutual fund investments, you'll often need to realize a higher income to make your mortgage payments than if that money was already in the form of home equity that didn't throw off any paper income. If you buy a $400k house and take out a 30-year mortgage for 80% of the value at 3.8% interest, that's roughly $1,500 per month that you'll need to liquidate from your investments to pay the mortgage, above and beyond what you would already need to liquidate to pay your other bills. How much income does this lead to? That really depends, but it's not nothing. This difference can lead to a rather significant difference to your health care expenses under the ACA. Furthermore the mortgage interest deduction is often less valuable in retirement than it was while working. Add both of these things on to your mortgage interest rate and holding that mortgage seems to be less of a good deal, relative to your other investment returns, than it was before retirement. Maybe you'll still come out ahead by investing, but the gap narrows a bit. Keep that, and sequence of returns risk, in mind when making your decision.

[ThisTooShallPass]

Thank you everyone for your valuable input.  I am now leaning more toward buying with cash for many of the reasons you folks said.  The important reason is the potential impact it will have on the ACA, and less value of mortgage interest deduction that seattlecyclone mentioned.   

I also read your old blog post SC..excellent write up! https://seattlecyclone.com/optimizing-the-affordable-care-act/

[conpewter]

...  My understanding is using the 2019 tax rules, a married couple can earn up to ~$24,400 /year without paying tax because of standard deduction. Other deductions like 401(k) contributions reduce taxable income. Once income and spending level exceed this level taxes must be paid, unless that income comes from qualified dividends or long term capital gains, which means $24,400 a year income PLUS ~$78,750 in investment income. So basically if income and spending are below these levels then we can avoid capital gains.   How do I confirm of this impacts ACA income threshold? thoughts?

Marcus by Goldman Sachs had a No-penalty CD @ 2.35% in 2019 and I signed up. It is lower for new members now.

I've always thought that the capital gains do count toward the income number.  I think you are still ok, but your combined income and capital gains will need to be below $78,750 in 2019 as a married filing jointly couple to avoid taxes on the capital gains

[seattlecyclone]

Yes, capital gains definitely count toward ACA MAGI. The standard tax formulas may assign a 0% value to this income, but it's still "taxed" in other ways such as through ACA phase-outs.

[MrThatsDifferent]

Thank you everyone for your valuable input.  I am now leaning more toward buying with cash for many of the reasons you folks said.  The important reason is the potential impact it will have on the ACA, and less value of mortgage interest deduction that seattlecyclone mentioned.   

I also read your old blog post SC..excellent write up! https://seattlecyclone.com/optimizing-the-affordable-care-act/

How funny, reading through the responses it seems the vast majority support taking the mortgage, not buying in cash. Always your call though.

[Dicey]

Thank you everyone for your valuable input.  I am now leaning more toward buying with cash for many of the reasons you folks said.  The important reason is the potential impact it will have on the ACA, and less value of mortgage interest deduction that seattlecyclone mentioned.   

I also read your old blog post SC..excellent write up! https://seattlecyclone.com/optimizing-the-affordable-care-act/

How funny, reading through the responses it seems the vast majority support taking the mortgage, not buying in cash. Always your call though.

Ha ha, I thought so too, but figured it was because of my well-known bias against prepaying the mortgage at the expense of other tax deferred savings. Oh well, can't win 'em all.

[Simpli-Fi]

I think this is a good debate due to the age of the retiree.  Cash purchase supports lower income which may decrease health insurance.  Mortgage increases required income which may increase health insurance but investing $320k over 30 years (remember 74 is the new 64) is quite a long time to grow and gives quite a bit of flexibility.

I don't quite see how Taking out a mortgage establishes a HUGE sequence of returns risk....especially when you have the capital to pay it off.

let's face it retired at 44, you will earn some money some way or another during the next 20 years