Author Topic: Oldie but a goodie: Should I get a mortgage or pay cash?  (Read 5859 times)

nudibranch

  • 5 O'Clock Shadow
  • *
  • Posts: 3
Oldie but a goodie: Should I get a mortgage or pay cash?
« on: February 04, 2014, 01:22:26 AM »
Hello MMM forums!  Iíve been reading for a few years but this is my first post.  And itís a slightly different take on a classic.  We are in the process of buying our first and potentially last home and my question is:  Should I get a mortgage or pay cash for a home? 

Having followed The Way Of The Moustache for some years, we have about twice the price of the home in our Ďstache.  (Not counting 401Ks or Roths.  I would not tap those to buy a house).  Our interest rate is 4.25% and, for the sake of discussion, letís say this is a $100,000 home.  We started with three options:

1)   Get a mortgage, put down 10%, pay PMI
2)   Get a mortgage, put down 20%
3)   Pay cash for the home (by liquidating Vanguard Index funds)

Weíve ruled out 1) on paying PMI based on this very helpful post pointing out that the effective interest rate for PMI is high:

http://www.mrmoneymustache.com/forum/ask-a-mustachian/pmi-payoff-roi/

Now Iím trying to decide if we should 2) get a mortgage with 20% down or 3) pay cash right from the start.  So letís do some math.  Paying off an $80,000 mortgage with a 4.25% interest rate is equivalent to paying $80,000 in cash up front.  And both of these are equivalent to an $80,000 investment with a guaranteed 4.25% rate of return.  This $80,000 investment will be worth $121,297 in 10 years and $278,851 in 30 years.  To model opportunity costs, I compared the guaranteed investment to simulated stock market returns for $80,000 based on the S&P500ís historical returns.  Over a 10 year period, the stock market only equaled or exceeded the $121,297 of the guaranteed investment 62% of the time.  Thatís not very compelling.  Over a 30 year period, the stock market equaled or exceeded the guaranteed investment 85% of the time.  (I tried to play with portfolio allocation a little bit but portfolios with bonds generally performed even more poorly).

The general wisdom is that you should take out a mortgage and invest the rest of the money because in the long term, the stock market beats the 4.25% rate the majority of the time.  And I have proven that to myself.  But I think I would like to retire in 10 years or less and Iím not sure that I want a mortgage hanging over my head at that time.  (Iím young-ish.  How will I deal with volatility and paying the mortgage in black swan years?  A bigger Ďstache?  More conservative investments?)  So, given that over a 10 year time frame, the stock market only beat the 4.25% guaranteed investment about half the time, Iím inclined to pay cash for the home right now.  What do you think?  (Thanks in advance.  Sorry to post and run, I will check back in later this week.)

nudibranch

  • 5 O'Clock Shadow
  • *
  • Posts: 3
Re: Oldie but a goodie: Should I get a mortgage or pay cash?
« Reply #1 on: February 04, 2014, 08:01:06 PM »
Bueller?  Bueller?

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 28062
  • Age: -999
  • Location: Seattle, WA
Re: Oldie but a goodie: Should I get a mortgage or pay cash?
« Reply #2 on: February 05, 2014, 07:57:02 AM »
It's the same question as "pay off my mortgage or invest?".

You're just choosing to pay it all off now, or keep it in investments.

They both have the same pros/cons though: peace of mind, not paying interest on one side, illiquidity, over exposure to real estate, less return on the other side.

If you do a search, there's lots of reading on this topic, and you'll find zealots on both sides*.

:)

*I, for one, would absolutely take a mortgage in your case.  But it is a very personal decision, and you can go read lots of arguments either way.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

lizzzi

  • Handlebar Stache
  • *****
  • Posts: 2111
Re: Oldie but a goodie: Should I get a mortgage or pay cash?
« Reply #3 on: February 05, 2014, 08:13:03 AM »
Pay cash, but be sure to save and invest whatever the house payment would have been. I like the feeling that I own my houseÖthe bank doesn't own it. But that's just me, and I know there are arguments either way. I would no more make a house payment than I would make a car payment, or carry a credit card balance. I know a house pymt. is considered "good debt" but I don't want any debt at all, "good" or otherwise. (Of course, if a person can't pay cash for the house, and has to get a mortgage, that is a different story. I'm not criticizing or judging what others do, and of course people have to have a roof over their heads.)

Another Reader

  • Walrus Stache
  • *******
  • Posts: 5104
Re: Oldie but a goodie: Should I get a mortgage or pay cash?
« Reply #4 on: February 05, 2014, 08:14:15 AM »
Another option would be to take a shorter term mortgage with a lower interest rate.  A 10 year mortgage will have a significantly lower rate and might be a good compromise.  Personally, I would never liquidate half of my taxable accounts just to avoid a mortgage.

Shor

  • Bristles
  • ***
  • Posts: 480
  • Location: Orange County, CA, USA
Re: Oldie but a goodie: Should I get a mortgage or pay cash?
« Reply #5 on: February 05, 2014, 09:27:02 AM »
Another option would be to take a shorter term mortgage with a lower interest rate.  A 10 year mortgage will have a significantly lower rate and might be a good compromise.  Personally, I would never liquidate half of my taxable accounts just to avoid a mortgage.
That's actually a good idea. You don't want the mortgage hanging over your head in to retirement, and you get a better interest rate off of it than a standard 30 year mortgage. The minimum payments will of course be higher, but that's not a problem if you already have the assets to cover it. There is still a risk of a market downturn within the mortgage duration, and then dealing with a mortgage which is bigger than your take home (maybe) while not wanting to sell at a loss in the heavy market, but so long as you can make the payments the rest of your investments can recover with time..

nudibranch

  • 5 O'Clock Shadow
  • *
  • Posts: 3
Re: Oldie but a goodie: Should I get a mortgage or pay cash?
« Reply #6 on: February 05, 2014, 11:18:57 PM »
Thanks guys.  It does seem to come down to risk tolerance and peace of mind.  Doing the math, the expected stock market return is higher than a 30 year mortgage interest rate so it seems obvious to get a mortgage.  Especially pre-retirement this probably makes sense.

But post-(early)-retirement, when living off a lower income and investments, the risk avoidance of not having a mortgage becomes more compelling.

Thanks for the advice and thoughts!

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 28062
  • Age: -999
  • Location: Seattle, WA
Re: Oldie but a goodie: Should I get a mortgage or pay cash?
« Reply #7 on: February 06, 2014, 07:41:28 AM »
But post-(early)-retirement, when living off a lower income and investments, the risk avoidance of not having a mortgage becomes more compelling.

Again, depends on the person.

I'd hate to have so much money tied up in a house in retirement, instead of having the money liquid.  If something went wrong, it's much easier to cash out stocks than a house.  Having a large sum tied up in equity is very risky to me.

All depends on your perspective.  ;)
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

EscapeVelocity2020

  • Handlebar Stache
  • *****
  • Posts: 2405
  • Age: 46
  • Location: Houston
    • EscapeVelocity2020
Re: Oldie but a goodie: Should I get a mortgage or pay cash?
« Reply #8 on: February 06, 2014, 12:24:19 PM »
OP, since you have so much flexibility, I would take a blended approach.  I'm not sure of your risk tolerance, job satisfaction, current asset allocation, income, age, or income stability, but you sound like you have a long time horizon so you should definitely have some exposure to equities.  If you have income and a pretty secure job, this is a bit like having a bond - regular payments that hopefully continue as long as you need them (with a high NPV that probably dwarfs your other assets).

So, depending on risk tolerance, definitely put the 20% down and maybe more if it would pain you too much to lose money in the market in the short term, causing you to jump ship after a sell-off.  But, by avoiding a mortgage before retirement, you are betting against history, that every rolling 30 year period up to today has had a real return that beats your mortgage expense (especially if you can use the tax deduction). 

You can bet against history, I have seen some economists getting concerned that we are in uncharted territory with low interest rates as well as high market valuation, but if you lose this bet then the person you could have been (experiencing ~4% higher delta returns (market vs. mortgage) for 30 years) will be almost 200k ahead on that 60k lump sum investment, vs. putting the theoretical mortgage payment amount slowly in the market.  ((For example, a 60k lump sum for 30 yrs at 8% nominal return = 604k vs. 3540 yearly mortgage payment, 30 yrs, 8% = 433k))

Another benefit to having a mortgage while you are working, it forces you to live within a reduced means.  When you retire, you should be in even better shape to make the decision to pay off or keep the mortgage.  I lean toward paying it off, since it will be an annoyance and so that you don't have a fixed liability when your income might be less predictable.  Again, you don't want to have to sell equities during a down market.  I also understand arebelspy, I've never paid off a mortgage because it's like having a pile of money that doesn't throw off any interest, dividends, or give you easy access to principal.  A mortgage, for working people, is like someone loaning some of your future income to you to invest. 

For extra credit, I'm partial to Another Reader's idea for a lower duration mortgage than 30 yr.  It lowers your interest rate, lowers overall interest paid, and increases the tax deductible interest paid, especially in the early years.  You can try to match the duration to your expected retirement date (10 years).

By the way, you are in great shape having the 80k liquid and planning on living in an 80k house!

Cassie

  • Walrus Stache
  • *******
  • Posts: 5790
Re: Oldie but a goodie: Should I get a mortgage or pay cash?
« Reply #9 on: February 06, 2014, 05:05:22 PM »
I would have never felt safe enough to retire without a paid off home-priceless in my opinion!!

SunshineGirl

  • Pencil Stache
  • ****
  • Posts: 749
Re: Oldie but a goodie: Should I get a mortgage or pay cash?
« Reply #10 on: February 07, 2014, 08:15:38 AM »
I don't know - as long as you have the cash to make your payments, maybe it's not so scary.

Daleth

  • Handlebar Stache
  • *****
  • Posts: 1201
Re: Oldie but a goodie: Should I get a mortgage or pay cash?
« Reply #11 on: February 07, 2014, 08:42:58 AM »
Thanks guys.  It does seem to come down to risk tolerance and peace of mind.  Doing the math, the expected stock market return is higher than a 30 year mortgage interest rate so it seems obvious to get a mortgage.  Especially pre-retirement this probably makes sense.

But post-(early)-retirement, when living off a lower income and investments, the risk avoidance of not having a mortgage becomes more compelling.

Thanks for the advice and thoughts!

We have 15-yr mortgages on our rental properties because that way they're free and clear by the time we have kids in college. They're at around 4% fixed, so there's no way it would've made sense to liquidate investments in order to get them in cash.

That said, it would make sense to liquidate a little bit if necessary to come up with 20% down. PMI is an utter screaming waste of money and a hassle to get out of.

jrhampt

  • Handlebar Stache
  • *****
  • Posts: 1074
  • Age: 42
  • Location: Connecticut
Re: Oldie but a goodie: Should I get a mortgage or pay cash?
« Reply #12 on: February 11, 2014, 10:24:22 AM »
The problem with liquidating your investments to pay for your house is that you typically take a tax hit on the capital gains.  How bad this is depends on your tax bracket - long term capital gains are actually at 0 for those in the 10 and 15% brackets.  Otherwise, you pay 15% (and most recently as of 2013 - 20% if you're in the highest tax bracket).  This is why, although we could pay off our house right now if we sold off some stock, we are not going to do it.