[Case study] Should I buy in cash?

[friendlybadger43201]

Hello! I'm a long time lurker with an old-but-goodie question for the current interest rate environment:

I'm planning to buy a small house (HCOL area, $500k). I could pay for it in cash, which would be about 70% of my total net worth (some in cash, some in equities I would liquidate). Or I could take out a mortgage at the prevailing interest rate of ~7%.

I see lots of advice on the forum historically says "Keep the low rate mortgage! Stay fully invested!" But... given that the current interest rates are so crazy, do they still qualify as low? What's the mustachian thing to do here--should I take out a mortgage?

Thanks in advance!

[friendlybadger43201]

PS I should probably say that I'm a first-time home-buyer, apologies for the newbie question! I just looked up the actual total cost of a $500k house over the course of a 30-year mortgage and it's terrifying.

[SilentC]

Pay cash and set up a HELOC so if the market tanks you can get cash out for buying SPY I mean “remodeling.”  7% after tax zero risk return is hard to do these days. 

[friendlybadger43201]

haha that's a good point! I guess my difficulty is that the rates I'm getting quoted for delayed financing/HELOCs are EVEN higher (7.5-8%) than the rates I'm getting quoted for mortgages. So the main point of taking out a loan now, if I were to do it, is just to lock in that lower-but-still-high rate of about 7%.

[ldigz]

Other options to get a lower rate: put down more than 20%, buy down the rate, choose a 15 or 20 year term.

Aimloan.com is showing rates around 4.3% for 500k with 30% down, 15 year term, and 2.7 points buy down (~$10k). They show the payment for many different options. (I found this lender from bankrate, back when bankrate still displayed lots of mortgage options. Lately they don't show very many at all.)

I've used bankrate recommendations for my last two mortgages.

[srad]

So the main point of taking out a loan now, if I were to do it, is just to lock in that lower-but-still-high rate of about 7%.

The  people who have the sub 3% mortgages have "Locked in" the rate.  They will never refi (or sell).  You my friend, will be "acquiring" a 7% mortgage and if/when the rates lower, you will refinance.  I do like the option idigz mentioned, put more down and get a shorter term loan.  Do the math on buying down the rate though.  Math never made sense for me in the past, but rates haven't been this high for 20 years.

And remember, if you do pay cash you can always do a cashout refi in a few years when the rates are lower. 

[waltworks]

I'd finance it. 7% is still below historical return of stocks, and you may have the opportunity to refi down the road. There are situations where the mortgage interest is deductible, too (if you rent the home out eventually, if you run a small business from your home, etc).

-W

[ChpBstrd]

I would neither buy the house nor take out the mortgage.

The unaffordability problem you are noticing is being faced by everyone, even with today's absurdly low unemployment, which means either interest rates have to fall or house prices have to fall.

If interest rates fall, you will regret taking out a mortgage in the 6-7% range because you'll be paying thousands of dollars to refinance in just a couple of years. If you paid cash, you might regret not investing in long-duration bonds instead of an unaffordable house.

Also, the "rates fall" scenario would typically be associated with a recession, which means your over-leveraged and now unemployed neighbors would be getting foreclosed on, potentially dragging down your property value. House prices rose almost 17% in 2021 - more in HCOL locales - so I think we should be able to imagine prices falling just as far and as fast as they rose.

If home prices fall, you will regret buying a home for cash or with a mortgage. You will have wished you spent another year in an apartment or with roommates, and pounced after the price decline instead of before.

I think we're due for a recession in late 2023 or early 2024. At that time, your $500k could be deployed buying stocks on the cheap, like people did in 2009-2010. Even now, your $500k could be earning 6%, or $30k/year, in a portfolio of investment-grade bonds and preferreds. Such a portfolio would appreciate in a "rates fall" scenario. I'd be a lot more excited about replacing a huge chunk of my spending than I would about a money-pit tract home purchased at a very risky time and at risk of losing six-figures of value.

[YttriumNitrate]

PS I should probably say that I'm a first-time home-buyer, apologies for the newbie question! I just looked up the actual total cost of a $500k house over the course of a 30-year mortgage and it's terrifying.

It's a lot less terrifying if you convert to inflation adjusted dollars instead of the absolute dollars listed on the payment sheets.

[SilentC]

I would neither buy the house nor take out the mortgage.

The unaffordability problem you are noticing is being faced by everyone, even with today's absurdly low unemployment, which means either interest rates have to fall or house prices have to fall.

If interest rates fall, you will regret taking out a mortgage in the 6-7% range because you'll be paying thousands of dollars to refinance in just a couple of years. If you paid cash, you might regret not investing in long-duration bonds instead of an unaffordable house.

Also, the "rates fall" scenario would typically be associated with a recession, which means your over-leveraged and now unemployed neighbors would be getting foreclosed on, potentially dragging down your property value. House prices rose almost 17% in 2021 - more in HCOL locales - so I think we should be able to imagine prices falling just as far and as fast as they rose.

If home prices fall, you will regret buying a home for cash or with a mortgage. You will have wished you spent another year in an apartment or with roommates, and pounced after the price decline instead of before.

I think we're due for a recession in late 2023 or early 2024. At that time, your $500k could be deployed buying stocks on the cheap, like people did in 2009-2010. Even now, your $500k could be earning 6%, or $30k/year, in a portfolio of investment-grade bonds and preferreds. Such a portfolio would appreciate in a "rates fall" scenario. I'd be a lot more excited about replacing a huge chunk of my spending than I would about a money-pit tract home purchased at a very risky time and at risk of losing six-figures of value.

4Q22 American Homes 4 Rent conference call - “It is 20% cheaper to rent than to buy” and ‘we are having difficulty buying properties accretively’ and ‘we are seeing vertical construction costs fall which will impact prices later in 2023 or 2024.’  It’s worth following them if you are in the market to buy.

[friendlybadger43201]

Thanks everyone! This is all really helpful (especially on the "don't buy just rent" piece which is a great option for all the reasons people are listing).

[August26th]

I would personally never give up 70% of my net worth in order to pay cash for a home. Seems scary.

There is a lot of info missing to make a solid determination, but if you’re set on buying the home, put a chunk down, take the 7% mortgage and then refinance when rates drop.

I prefer buying over renting for the long term, for tons of reasons discussed on the forum, but you need to be comfortable with the roughly $2,600 principal and interest payment you’d be taking on at a 7% rate with 20% down on a 500K purchase price.

[Shuchong]

I would personally never give up 70% of my net worth in order to pay cash for a home. Seems scary.

There is a lot of info missing to make a solid determination, but if you’re set on buying the home, put a chunk down, take the 7% mortgage and then refinance when rates drop.

I prefer buying over renting for the long term, for tons of reasons discussed on the forum, but you need to be comfortable with the roughly $2,600 principal and interest payment you’d be taking on at a 7% rate with 20% down on a 500K purchase price.

Another vote for not buying with cash.  What if you lose your job, or get sick/disabled, or some other financial disaster befalls you?  If all of your money is sitting in your house, it is really hard to access it for other things.  (Yes, you could in theory get a HELOC, but probably at worse terms, and banks don't have to give those to you.)  Liquidity has quite a bit of value.  Also consider the tax consequences of liquidating your equities. 

I get it, I'm not a fan of debt, but if I were you I'd either take a mortgage and live with the payments, or reassess whether I really wanted the house. 

[Must_ache]

I agree with ChpBstrd, consider not buying at all.

A 30-yr mortgage payment for a $500K house would cost:
4%: $2,387
5%: $2,684
6%: $2,998
7%: $3,327

By historical standards a 7% mortgage isn't outrageous, we've been used to low interest rates for a couple decades and that has allowed house and asset prices to generally mushroom.  With mortgage rates only high fairly recently, it just doesn't feel to me like we have had the corresponding drop in house and asset prices that we should have.  Going from 4% to a 7% interest rate increases the price of the house by about 40%. 

https://fred.stlouisfed.org/series/MSPUS

If you look at this chart, the median sale price vaulted from $322,600 in 2020Q2 to $468,000 in 2022Q3, and just last quarter slid backwards by all of $300.  That might be the first sign that higher interest rates are barely beginning to have some traction to tame inflation.  There is a massive difference between the payment for a $323K house @ 3% and a $468K house @ 7% and I could be wrong but I think it will take time for this to unwind.

On that graph around the recession of '08 the median house price dropped from $257K to $208K (-19%) and it doesn't even look anything like the run-up we've had now.  I sold a small house near the peak of that runup for $210K and a couple years later it was at $120K.  They sold it 15 years later for $195K.  In less than three years that house price has run up to $276K according to Zillow which is cray-cray.

So I would hate to see you buy a house for $500K and have it be worth $400K or less three years from now. 

[Cassie]

I would put down half and finance the other half.

[PMJL34]

Interesting to hear all of the posters saying not to buy.

I thought it was almost universal to buy when you are 1. ready to be in the home minimum of 5 years (give or take) 2. can afford it.

OP,

If you don't buy...what are your options/current living arrangement?

To answer OP's question. I'd pay cash if APR is higher than 5.5%. Best case scenario, APR goes down, prices go up, and you can cash out refi. Worst case scenario, APR continues to rise and prices go down. If you are committed to the home and area, the downside doesn't seem too bad imo.

Best of luck!

[SilentC]

Interesting to hear all of the posters saying not to buy.

I thought it was almost universal to buy when you are 1. ready to be in the home minimum of 5 years (give or take) 2. can afford it.

OP,

If you don't buy...what are your options/current living arrangement?

To answer OP's question. I'd pay cash if APR is higher than 5.5%. Best case scenario, APR goes down, prices go up, and you can cash out refi. Worst case scenario, APR continues to rise and prices go down. If you are committed to the home and area, the downside doesn't seem too bad imo.

Best of luck!

I get that view but look out the window and it’s raining rental townhomes and houses, rents are edging lower and 20%+ less expensive than a mortgage and I can have a downpayment in 3 year IG bonds paying me 6%.  Central CO.  Oh and prices have been falling almost every month since the fall, so basically zero pressure to own.  If rates go to 4%s then the picture will change I assume.

[Swish]

I'd buy something larger with an option to rent space to cover the majority of my mortgage. If this is the only option I'd pay cash if I have a low income job and mortgage it if I make good income pay high tax and can deduct the interest of the mortgage against my income to reduce my taxes. In this scenario the effective interest rate may be a lot closer to 4% depending on your salary & respective tax bracket.

[Swish]

I get that view but look out the window and it’s raining rental townhomes and houses, rents are edging lower and 20%+ less expensive than a mortgage and I can have a downpayment in 3 year IG bonds paying me 6%.  Central CO.  Oh and prices have been falling almost every month since the fall, so basically zero pressure to own.  If rates go to 4%s then the picture will change I assume.

@SilentC are rents really edging lower in your area? In ours rents are up 20-25% for apartments and 30-40% for family homes as the higher interest rates have drastically reduced the number of first time home buyers that are able to pass the cashflow tests to buy so now all those people are continuing to rent. The cost of homes has come down but the cost per month on cash flow is up a fair amount compared to 2 years ago so anyone not sitting on a good amount of cash has lost the option of buying.

[SilentC]

I get that view but look out the window and it’s raining rental townhomes and houses, rents are edging lower and 20%+ less expensive than a mortgage and I can have a downpayment in 3 year IG bonds paying me 6%.  Central CO.  Oh and prices have been falling almost every month since the fall, so basically zero pressure to own.  If rates go to 4%s then the picture will change I assume.

@SilentC are rents really edging lower in your area? In ours rents are up 20-25% for apartments and 30-40% for family homes as the higher interest rates have drastically reduced the number of first time home buyers that are able to pass the cashflow tests to buy so now all those people are continuing to rent. The cost of homes has come down but the cost per month on cash flow is up a fair amount compared to 2 years ago so anyone not sitting on a good amount of cash has lost the option of buying.

They are.  I live in burbs outside of Denver.  I’m seeing a lot of people list their house, not get March 2022 price for it and then turn it into a SFH rental and the price per bedroom has been falling as a result of increasing supply (more and more people being “forced” landlord) or fewer relos or whatever.  I’m seeing identical units fall in rent ask $50 or $100 over the past six months and y/y price declines at a few apartmen complexes I track as much as $150 (call it -5%).  It’s all local but I think people really slowed down moving here coupled with gobs of multi-family completions in recent quarters.

Edit- waltworks or ChpBstrd posted a link on this thread or another one recently showing national rent declines for six months so your hood might be an exception.

[Swish]

@SilentC ya that is nuts definitely not what we are seeing up here in my part of Canada.

[Jon Bon]

Would you put 70% of your net worth into a single stock?

A single stock that takes at minimum 60 days to process and costs 6% commission to sell?

[PMJL34]

Jon Bon,

Isn't that how you/me/most everyone buys their 1st home (by spending most, if not all, of your networth/savings)?

Keep in mind, it's also a primary home for OP. It will also spit out some rental income. It will also save 6-7% APR, right?

 

[Jon Bon]

1st timers do it because they are forced too, because they don't have high six figures in cash available to them.

OP could easily put down 20% or a bunch more. But I don't think the potential interest savings are worth it to pay in full. There is always a chance interest rates fall and OP could refinance. If interest rates go up they are also protected as their loan hedges against rising rates.

I also think waiting a little while might be a solid move, likely you get lower housing prices and lower interest rates. But my crystal ball has been on the fritz lately.

[waltworks]

@SilentC ya that is nuts definitely not what we are seeing up here in my part of Canada.

Rents have been dropping in the US (with local/regional variations, obvisouly) for the last 6 months. There is also a HUGE amount of multifamily under construction that will finish this year and next, so there will be considerable additional downward pressure on rents.

https://calculatedrisk.substack.com/p/year-over-year-rent-growth-continues

-W

[SilentC]

Would you put 70% of your net worth into a single stock?

Absolutely.  I would do 100% if it was a cinch.

[Zamboni]

I have found Waltworks to be a reliable barometer of the real estate market in the past.

Also, my brother is a skilled construction tradesman in a booming area. He is starting to see the biggest sub contractors put bids on smaller projects that they normally would never do. He thinks it is just to keep their guys busy, and they are nearing doing it for no profit. Last time he saw this was 2007-8.

Denver has been booming for a long time, but it is not immune from a pull back. Is the inventory starting to increase in your burb? Are houses starting to have price cuts?

Good luck, whatever you decide.

[Swish]

Would you put 70% of your net worth into a single stock?

A single stock that takes at minimum 60 days to process and costs 6% commission to sell?

Depends on the stock ;)

[Prancing Llama]

I would neither buy the house nor take out the mortgage.

The unaffordability problem you are noticing is being faced by everyone, even with today's absurdly low unemployment, which means either interest rates have to fall or house prices have to fall.

If interest rates fall, you will regret taking out a mortgage in the 6-7% range because you'll be paying thousands of dollars to refinance in just a couple of years. If you paid cash, you might regret not investing in long-duration bonds instead of an unaffordable house.

Also, the "rates fall" scenario would typically be associated with a recession, which means your over-leveraged and now unemployed neighbors would be getting foreclosed on, potentially dragging down your property value. House prices rose almost 17% in 2021 - more in HCOL locales - so I think we should be able to imagine prices falling just as far and as fast as they rose.

If home prices fall, you will regret buying a home for cash or with a mortgage. You will have wished you spent another year in an apartment or with roommates, and pounced after the price decline instead of before.

I think we're due for a recession in late 2023 or early 2024. At that time, your $500k could be deployed buying stocks on the cheap, like people did in 2009-2010. Even now, your $500k could be earning 6%, or $30k/year, in a portfolio of investment-grade bonds and preferreds. Such a portfolio would appreciate in a "rates fall" scenario. I'd be a lot more excited about replacing a huge chunk of my spending than I would about a money-pit tract home purchased at a very risky time and at risk of losing six-figures of value.

4Q22 American Homes 4 Rent conference call - “It is 20% cheaper to rent than to buy” and ‘we are having difficulty buying properties accretively’ and ‘we are seeing vertical construction costs fall which will impact prices later in 2023 or 2024.’  It’s worth following them if you are in the market to buy.

How do I find out about those calls in advance? Interesting.

[Prancing Llama]

I get that view but look out the window and it’s raining rental townhomes and houses, rents are edging lower and 20%+ less expensive than a mortgage and I can have a downpayment in 3 year IG bonds paying me 6%.  Central CO.  Oh and prices have been falling almost every month since the fall, so basically zero pressure to own.  If rates go to 4%s then the picture will change I assume.

@SilentC are rents really edging lower in your area? In ours rents are up 20-25% for apartments and 30-40% for family homes as the higher interest rates have drastically reduced the number of first time home buyers that are able to pass the cashflow tests to buy so now all those people are continuing to rent. The cost of homes has come down but the cost per month on cash flow is up a fair amount compared to 2 years ago so anyone not sitting on a good amount of cash has lost the option of buying.

Exactly the same situation near me

From 2015 to 2023 a one bedroom apartment here has gone up 75%. Most of that was since 2020 when it was only like 15% higher than 2020.

[MustacheAndaHalf]

I'm strongly in favor of 30 year fixed rate mortgages... but not right now.  Consider an adjustable rate mortgage (ARM) for the current high inflation environment.  This involves taking risk that inflation surges even higher, as it has in the UK.  But historically, inflation tends to run far lower, so eventually rates are very likely to fall. With an ARM (after the initial fixed period), the mortgage payments drop when rates fall.

[Cranky]

How hot is your market and how much do you want a house (and why?) I’m currently in an area where housing prices are skyrocketing and we just bought a condo and almost every accepted offer now is cash. It’s nuts.

[eddy20]

Finance the house and re-fi when rates go down. Sounds like you are well qualified buyer in a buyer's market, negotiate your best price and don't worry about the loan's current interest rate. Hold on to your cash!

[clifp]

I'm strongly in favor of 30 year fixed rate mortgages... but not right now.  Consider an adjustable rate mortgage (ARM) for the current high inflation environment.  This involves taking risk that inflation surges even higher, as it has in the UK.  But historically, inflation tends to run far lower, so eventually rates are very likely to fall. With an ARM (after the initial fixed period), the mortgage payments drop when rates fall.

I second that, you'll save about 1% and the cost and hassle of refinancing when they likely drop in the next few years.  It is certainly possible we could see another 1% higher fed funds rates and higher mortgage, but then you'd basically be breaking even. Alternatively, look at 15-year fix rate loans.