Why You May Not Want to Pay Cash, Own Your Home Free and Clear

NEW YORK (MainStreet) — Cash sales of homes are declining, and could return to normal levels in a couple of years. But although that's good news, cash deals will continue to make sense for some homebuyers.

Determining if that's so is, well, complicated, and hinges on market conditions that change constantly.

CoreLogic, the real estate data firm, says cash sales made up 35.5% of home sales in December, down from 38.5% a year earlier and a peak of 46.5% in January 2011. 

"Prior to the housing crisis, the cash sales share of total home sales averaged approximately 25%," CoreLogic said. "Should the cash sales share continue to fall at the same rate that it did in December 2014, the share should reach 25% in mid-2017."

This is good news because the high level of cash sales was caused by market troubles. Many ordinary buyers could not get a mortgage, so sales levels dropped and cash deals made up a larger portion of what was left. Speculators rushed into the market, paying cash for foreclosures and other "distressed" sales. Now, as the market recovers, speculators are backing away.

Still, cash purchases will continue to make sense for some ordinary buyers. Downsizing retirees, for example, can buy a less expensive home, pocketing the difference for living expenses and avoiding the burdens of a mortgage. Many retirees without ordinary income cannot get a mortgage anyway.

But what about those with an option — to borrow or pay cash?

Cash buyers are more attractive to sellers because the sale does not hang on a mortgage approval, says Investopedia, the investment and personal finance site. That can help the buyer get a better deal.

With a cash deal, the buyer not only avoids interest expense over the years but doesn't have to pay for mortgage insurance, or for various closing costs such as loan application fees, Investopedia says. If you know what you are doing, you might even forgo the appraisal.

Also to be considered is the peace of mind that comes from owning a home free and clear. Though a large sum is tied up in the home, avoiding a mortgage payment can dramatically reduce monthly expenses.

HSH.com, the mortgage and housing information firm, says the key to making this decision "is to view your mortgage as an investment like any other with liquidity, risk and return."

Using cash allows the homeowner to avoid mortgage interest charges. In effect, the cash earns a return equal to the rate that would have been paid on a mortgage. Today, that means earning around 4%, the average charged by the standard fixed-rate 30-year mortgage. Four percent isn't much compared with stock market returns for the past few years, but stocks are risky, while the return on cash put into a home is guaranteed. Earning 4% is not bad if the alternative is less than 1% in bank savings.

But money put into a home is hard to get out, requiring that the homeowner sell or take out a new mortgage or home equity loan, which could be difficult or impossible if you don't have a regular job at that point. A cash purchase could backfire if the homeowner avoided a loan at today's low rates only to resort to a higher-rate loan in the future. So a cash purchase probably doesn't make sense if it will take every last dime, leaving the buyer with no financial cushion.

What about losing the federal tax deduction for interest on a mortgage? While it's worth running the numbers, this benefit often isn't as valuable as homeowners think. It only pays off to the extent that interest and other itemized deductions exceed your standard deduction. And it doesn't pay to spend a dollar on interest just to get 25 cents back in taxes.

One option: Split the difference. Use some of the cash for a larger-than-usual down payment of 30%, 40% or 50%. You'll reduce your monthly payment dramatically but keep a wad of cash for other purposes.

Another option is to pay in cash and then take out a home equity line of credit to pay for emergencies. Once the credit line is established, you'll have no interest charges until you actually use it.

— Written by Jeff Brown for MainStreet

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