- Credit Card
- Real Estate
I can afford to buy a house (to live in myself) in cash. Most of my investor friends tell me this would be a dumb idea, because I could earn more in interest by buying the house with a mortgage and investing the rest of my money.
I get their arguments, but they appear based on less-than-certain assumptions:
I’d be able to get a reliable return on my investment higher than what I pay in interest for the mortgage.
I’d keep the mortgage long enough for my investment returns to exceed the cost of interest.
1 is probably a safe assumption, although by no means a given. Currently, no guaranteed-return investment instruments (e.g., CDs) would come close to paying an interest rate that equals or exceeds the ~3.5% interest I’d pay on a mortgage. The stock market does beat that, of course, but it could tank.
2 is where I think a lot of people fail to understand the financial benefits of buying a house in cash. Because of amortization, the amount I would pay in interest each year for my mortgage would be very high at the start of the mortgage, and would decline gradually. Effectively, the cost of the mortgage in the first year would be much higher than the nominal ~3.5 percent interest rate of the loan.
As a result, I’d have to keep the mortgage for more than a decade before my yearly investment returns started to exceed what I pay in interest each year on the mortgage. Given that most mortgages last only 5-7 years before people refinance or move, it seems uncertain that I’d end up with more money in the long run by taking out a mortgage.
At the end of the day, buying the house in cash seems smarter to me, which is effectively the same as getting a guaranteed return equal to what I’d otherwise pay in interest for the mortgage — which, again, would be many thousands of dollars in the first year I own the house.
(Also, another reason not to get a mortgage is the new US tax law’s implication that I, along with 94% of the rest of the country, will not itemize my deductions because I won’t hit the standard deduction. There are, effectively, no tax advantages for mortgages anymore for most people.)
For the record, my main reason for buying the house in cash is emotional, not financial. I’ll sleep better knowing that if I were to lose my job, I won’t have to worry much about leaving the house, because my only major monthly expenses are property taxes (which are pretty hefty here in New York, but still less each month for this five-bedroom house than it would cost to rent a one-bedroom apartment in the same town).
Still, I’m looking for an answer for my friends who are overlooking the complexities of mortgage amortization and how that impacts the real cost of a loan within the first decade or so. Am I wrong?