Finance house or pay cash?

[soupcxan]

We're early 30s DINKs, an employer relocated us to Houston last year and have been renting a house for +$2k/mo, the lease expires later this year. We sold our last house when we moved which was paid off and got ~$250k for it. Plus other savings we have almost $500k in bank savings accounts earning 1% right now. We also have almost $600k in investment accounts across our 401ks, IRAs, and taxable accounts. Only debt is $40k of student loans at 2.5% (non-deductible). Income is +$300k/yr so deduction phase-outs and possibly AMT will hit us on our 2013 taxes.

The real estate market in Houston is superheated right now. Inventory is way down and homes in desirable areas sell within days; some buyers are making all-cash offers. Not a great time to buy but we really don't want to rent for another year. We expect to be here several years, at least. Also we are limited in the areas we'll consider because our jobs are on opposite sides of the city, and traffic is killer.

Depending on the area we're looking at houses in the $250-500k range so could conceivably write a check, or could finance at today's rates <3%. I'm aware of the tradeoff between expected investment returns vs. the cost of financing but if I could predict future stock market returns, I wouldn't be living in Houston. The company will pay closing & financing costs for us as part of our relocation.

What would you do in this situation?

 

[jimnjana]

I'd lock in financing as an option. If paying cash gets you the house you want then you can always do it.

 

[Lazarus]

If you are only going to be there a few years, rent.

If one or both jobs could change, rent. The compromise on location with the jobs on two ends of the city won't look good if one goes away.

 

[LeavingOhio]

We're early 30s DINKs, an employer relocated us to Houston last year and have been renting a house for +$2k/mo, the lease expires later this year. We sold our last house when we moved which was paid off and got ~$250k for it. Plus other savings we have almost $500k in bank savings accounts earning 1% right now. We also have almost $600k in investment accounts across our 401ks, IRAs, and taxable accounts. Only debt is $40k of student loans at 2.5% (non-deductible). Income is +$300k/yr so deduction phase-outs and possibly AMT will hit us on our 2013 taxes.

The real estate market in Houston is superheated right now. Inventory is way down and homes in desirable areas sell within days; some buyers are making all-cash offers. Not a great time to buy but we really don't want to rent for another year. We expect to be here several years, at least. Also we are limited in the areas we'll consider because our jobs are on opposite sides of the city, and traffic is killer.

Depending on the area we're looking at houses in the $250-500k range so could conceivably write a check, or could finance at today's rates <3%. I'm aware of the tradeoff between expected investment returns vs. the cost of financing but if I could predict future stock market returns, I wouldn't be living in Houston. The company will pay closing & financing costs for us as part of our relocation.

What would you do in this situation?

You say "several years", and the rule of thumb to buy a house is always 5 years, but in my opinion, you should PLAN to be in a house for 15 years if you want to buy. Plans can change, but any plan that is much less than 15 years and you could lose your shirt on buying a home...by the time you pay realtor commissions, fix it up nice enough to sell, etc., you might be negative even if the price went up a little after just 5 years or so. 15 is better. If you don't want to be there that long, then just rent.

If I may be so bold also, is there a reason why you have half a million dollars sitting in a bank account earning just 1%? I guess because the $250,000 from the house sale went in there?

Everything else looks awesome...even your student loan debt which isn't insignificant is low compared to your income.

IF you buy, I suppose it doesn't matter how much of a house you buy...with that income and no kids (especially if none are planned), you can afford to buy a million dollar house if you want. Your target area of $250,000-$500,000 sounds great though. You had a paid-for house before, so why not just write a check for this one and be done with it? Just frees up income to do other things with...travel, pump more into retirement accounts, buy stuff, etc. Even if you like a big bank account balance, if you deplete it with the purchase of a home, you can quickly get it back to $100,000 or more with that income of yours when you have no kids and no mortgage payment.

Again though, I am really against buying a home unless you plan to be in it for at least 15 years.

 

[MichaelB]

Depending on the area we're looking at houses in the $250-500k range so could conceivably write a check, or could finance at today's rates <3%. I'm aware of the tradeoff between expected investment returns vs. the cost of financing but if I could predict future stock market returns, I wouldn't be living in Houston. The company will pay closing & financing costs for us as part of our relocation.

What would you do in this situation?

Does the company reimburse realtor fees and other selling costs as well?

 

[soupcxan]

Does the company reimburse realtor fees and other selling costs as well?

The company paid the selling costs for the home we moved out of and will pay the buying costs for a new home. They won't pay another set of selling costs unless they are relocating you, but it would be fairly unlikely for them to move us again for several years, if ever.

Obviously if one of us stopped working then we would have a lot more flexibility in house locations. But we have no firm plans on that and waiting multiple years for that to become clear while we rent is not want we want to do. And there's always the risk one/both of us could get laid off tomorrow.

 

[MichaelB]

The company paid the selling costs for the home we moved out of and will pay the buying costs for a new home. They won't pay another set of selling costs unless they are relocating you, but it would be fairly unlikely for them to move us again for several years, if ever.

I can see how the decision is not so straightforward. Buying and selling costs eat up lots of real estate value, when combined with taxes and maintenance, often point to renting as the preferred option. Without those costs the calculus changes.

Do you consider this cash part of your portfolio, looking for the right investment opportunity, or is it just cash in the bank ready to help you deal with an unexpected situation? Easy to ask, I know.

 

[Animorph]

Get the loan, with the lowest closing costs. You can always pay it off whenever you want. Prequalifying might speed things up and help you compete a little better. While there is no guarantee with portfolio returns, there should be a much better than 50% chance they will exceed 3.5% over the next 20 years. And you preserve your house purchase interest tax deduction.

 

[martyb]

Get the loan, with the lowest closing costs. You can always pay it off whenever you want. Prequalifying might speed things up and help you compete a little better. While there is no guarantee with portfolio returns, there should be a much better than 50% chance they will exceed 3.5% over the next 20 years. And you preserve your house purchase interest tax deduction.

This is the approach DW & I are taking. We're very close to buying a house, and will be financing. We will negotiate for the seller to pay all or most closing costs. In a couple of years or so, if we choose to, we may or may not pay off all or most of the mortgage.

 

[EllisWyatt]

I can appreciate the conundrum you're in. Here's my two cents (and probably overpriced at that)....

I was in a similar situation in 1984 - got transfered to Houston with megaoilcorp, who had a relo package that paid all closing costs and "guaranteed" repurchase of house upon future transfer. Also, due to the high interest environment (15%+ interest rates) subsidized my loan down to 10%. The housing market in Houston at the time was booming (in retrospect, we now call that "superheated").

We bought a house, lived in it for 3 years, and were transfered.

By then the oil industry had collapsed, and with it the housing prices in Houston. We sold our house for 45% of what we'd bought it for 3 years earlier, and felt lucky to get that. (BTW, the "guaranteed" buyback used the three foreclosures in the neighborhood as comps - would have given us a 65% loss vs. the 45% we got on the open market).

This remains the only loss I've ever had on a house, and significantly set us back financially for several years. Our neighbors and good friends finally sold thier house after ten years for a price that matched their remainng mortgage balance.

While Houston has diversified their economy a lot since the 1980's, oil is still king, and if/when the price of oil drops significantly, so will the Houston real estate market.

So...... my recommendation : If you're only going to be a a few years (ie., less than ten), keep renting.

 

[Pauline RFIndependence]

I would opt for financing, with a good deposit down. You can always pay it off later and with your company offering to pay the costs it looks like a good opportunity. I would invest the cash in another rental property or income generating asset. A rate under 3%, minus inflation and tax deductions is really cheap money, and you keep your options open.

 

[haha]

You are employed. You have decided to buy, the question is should you finance. In my opinion yes, unless for whatever reason you can get a much better price by showing up with a cash offer.

In some seller situations, it doesn't matter. THe houses are standard, easy to value, the buyers look easy to finance, etc.

But there are other situations where cash can buy you a much better price. Maybe the seller needs to move elsewhere for a job, a new love, or other things that she perceives as very important. And possibly a deal or two has collapsed. Maybe owner is deceased or in a nursing home, and the selling is being handled by children or even sibs who might value a done deal much more highly than more money possibly available to be split between them at some future date. Then there is often motivation to get the property tax monkey off their backs.

I have paid cash, but only with a meaningful concession by the seller to the fact that cash is actually more secure and more certain in many cases than a financed sale.

When I bought my condo fall 2011 i copied a brokerage statement with everythng blacked out but my name and address and the cash amount to do the deal. So the seller, and my own agent, knew only that I had the money to perform, but I let them believe that this amount would leave me tapped out so that they might not be very motivated to try to get me up. No blood in a turnip, etc. I had to play the part of one who had a limited amount to money to buy a condo, but who was flexible and very willing to move on-which was easy for me, as it is accurate. I had looked at a lot and knew that this place was very well priced, and had no flaws that were meaningful to me but I did not share this information

I definitely had my agent come to my apartment several times, as it was attractive and in a high prestige location, and i have never seen an agent who wasn't moved by these things. She knew (or thought whe knew) that I did not care if we couldn't do this deal, and that i would not necessarily or even likely continue to let her show me around. It is easy to conflate the agent's interests with the seller's or buyer's, but they are not the same.

To my way of thinking, real estate transactions are quite complex, in many different ways.

So if you are considering paying cash, be sure that you get something special for this.

Ha

 

[pb4uski]

I agree with others that if you will only be there several years given the real estate price volatility in Houston over the years that it would be better to rent than own, but that is not the question that you asked.

At your current level of income would you get much benefit from a mortgage interest deduction or would the benefit phase out? If you would get little benefit from the mortgage interest deduction it may be better to pay cash than finance since your investments are unlikely to earn ~3% after-taxes.

 

[SJ1_]

We're early 30s DINKs, an employer relocated us to Houston last year and have been renting a house for +$2k/mo, the lease expires later this year. We sold our last house when we moved which was paid off and got ~$250k for it. Plus other savings we have almost $500k in bank savings accounts earning 1% right now. We also have almost $600k in investment accounts across our 401ks, IRAs, and taxable accounts. Only debt is $40k of student loans at 2.5% (non-deductible). Income is +$300k/yr so deduction phase-outs and possibly AMT will hit us on our 2013 taxes.

The real estate market in Houston is superheated right now. Inventory is way down and homes in desirable areas sell within days; some buyers are making all-cash offers. Not a great time to buy but we really don't want to rent for another year. We expect to be here several years, at least. Also we are limited in the areas we'll consider because our jobs are on opposite sides of the city, and traffic is killer.

Depending on the area we're looking at houses in the $250-500k range so could conceivably write a check, or could finance at today's rates <3%. I'm aware of the tradeoff between expected investment returns vs. the cost of financing but if I could predict future stock market returns, I wouldn't be living in Houston. The company will pay closing & financing costs for us as part of our relocation.

What would you do in this situation?

Assume $400,000.
Assume 2.875% loan with no orig. fee closing costs etc. (impossible)
If you mortgage it you will pay
the following interest for the 1st 5 yrs.
$11,388.23
$11,139.83
$10,884.20
$10,621.12
$10,350.37
$54,383.75 TOTAL INTEREST
You will make roughly $4,000 interest or $20,000 in 5 yrs.
so the diff. is $54,383-20,000=$34,383 cost to you

If you pay $400,000 cash
you would miss out on $4,000 per yr. but would not have to pay $54,383.

I would pay cash.

this logic works in reverse.
my house is paid for.
should I take out a loan at 2.75% and put it in a 1% savings?
no way.

congrads. on saving so much !

 

[Texas Proud]

What area are you looking

I do not see any superheated sales up where I live.... my place is not that bad either...


As to your question... I agree with a lot of what people are saying... the first decision is buy or rent... from what I see on lease rates, they are high compared to the cost of buying... so, if you are going to be here for awhile I would buy....

Next is location... you said you and DW work on opposite sides... is this subject to a possible change? Do you like an area more than another? Are you an 'inner-loop' couple? Would you move closer to your work if your DW lost her job or decided to stop working? What if it were the opposite and it was you? Again, lots of possibilities that go back to the buy/rent question.

For me, I would buy and invest some of that money in the market... over the 15 or 30 years of your loan you probably would make out much better than paying cash...


Edit to add.... just checked and there are 135 properties in my zip code that have price reductions... still would like to know where it is over-heated....

 

[photoguy]

If I were planning on buying, I'd definitely finance unless you get substantial consideration for paying cash. This preserves the walk away option plus even the most pessimistic forecasts of equity returns I've seen are higher than 3%.

I also wouldn't keep 5/11 of my portfolio in cash.

 

[PatrickA5]

With the kind of cash you have, I'd probably just pay cash. But, do what your comfortable with. I wouldn't use ALL of your money on a house, but if you buy a $250K house and still have a ton of money left over, I don't really see any reason to finance it.

Don't make a mortgage decision based on the interest deduction. First, you'll probably soon start phasing out of itemized deductions. Second, Texas doesn't have an Income tax, so you don't get that big itemized deduction for state taxes that would fill up the standard deduction amount - in effect making your entire interest payment deductible. Besides, paying a dollar in interest to save 35 cents in taxes is never a good deal. Finally, my guess is if we ever see real tax reform the mortgage interest deduction for high earners, IMO, will be one of the first done away with.

Finally, when you paid off your old house - did you ever get the urge to take out a big HELOC and invest it in the market? Taking out a mortgage and investing the difference in the new house is the same thing. Back in 2000, I actually had friends that did this. Took all of the equity and invested it because they just KNEW they could do better with the money in the market. Then came the dot.com bust. They're still paying on the HELOC.

 

[W2R]

I'm aware of the tradeoff between expected investment returns vs. the cost of financing but if I could predict future stock market returns, I wouldn't be living in Houston. The company will pay closing & financing costs for us as part of our relocation.

What would you do in this situation?

Me?

If I was not certain that I would be living there in 5-10 years, then I'd rent.

If I decided to buy then I would pay cash. But I am on the "pay off the mortgage" side of that eternal debate. I'd find out what the property and school taxes are on any house I might consider buying in Texas, before signing the papers.

 

[Katsmeow]

I live in a county adjacent to Houston and recently faced the decision with a new house to have a mortgage or not. Basically with the current rates we felt it was preferable to have a low rate mortgage with about 40% equity. We haven't put the cash in a bank paying 1% interest. Rather we invested it as part of our normal asset allocation. We felt that given the current rates this made the most sense and we could always pay off the loan if we wanted to.

 

[obgyn65]

I would pay cash also. I paid my own place cash, no regrets.

 

[soupcxan]

The decision here is not lease vs buy, it is how to finance. The rental market in houston is even worse than the buying market, rents increased 16% last year and good properties were getting leased within hours of coming on the market (as I quickly learned). The rentals in our market had a price-to-rent ratio of <15 implying a bad deal for renters. The problem is all of the non-price-sensitive oil expats are increasing demand and the housing stock can't respond quickly enough because of poor urban planning, no zoning, and poor transportation infrastructure.

Anything could happen but I think there is a >50% chance we'll be here more than 5 years so want to buy (avoid rent increases, avoid having to move every year, be able to customize the space, etc.).

 

[ShortInSeattle]

This seems to be a similar question to the often asked "should I pay my mortgage off early" one. Basically that's what it is, right? A big total prepayment.

You might find perusing those threads to be useful as well.

In our case, we decided to put a healthy downpayment on our place, then invest the difference, realizing that we can always pay it off out of our portfolio if life changes. We didn't need to get a loan, but we preferred to leave that money as investments rather than paying in full.

We're betting that our money will do better in the market over the next 10-15 years plus than being used to pay down a low rate loan.

If one or both of us cannot work and low expenses becomes a bigger concern, we'll pay it off.

As the "should I prepay" threads will tell you, it's a hotly contested question. It seems to be a personality decision more than a financial one.

If you do decide to buy, I hope you'll consider limiting the price of your home to 2x your income or less. Big fat mcmansions can get in the way of early retirement goals, should that be your goal.

SIS

 

[rodi]

If the market is truly heated, cash might be the only way to get your offer to the top of the pile.

I live near a super hot micro-market and work in the area. Redfin just named this micro market the 2nd hottest market in the country... Mira Mesa.

Which Neighborhoods Will Be the Hottest in 2013? | Redfin Blog

Friends are desperately trying to buy - (good investment opportunities because the tech center produces lots of potential high-income, renters.)
They are either offering all cash, or getting blown away by all cash offers.
One friend who just bought a 3/2 SFR paid all cash - then financed it as soon as it closed. He borrowed from his 401k to do this and was able to refund the 401k loan within a month. (Not recommending this).

Hot markets sometimes require cash offers... That doesn't mean you need to be mortgage free forever. I'm pretty sure there is some rule about putting financing in place within 30 days... forgot what the implication was if you don't get it done in time.

 

[GrayHare]

Mortgage. With rates at and even below inflation, you are repaying with devalued dollars, thus a mortgage is essentially free money, and that's before considering any potential tax deductions.

 

[haha]

In our case, we decided to put a healthy downpayment on our place, then invest the difference, realizing that we can always pay it off out of our portfolio if life changes. We didn't need to get a loan, but we preferred to leave that money as investments rather than paying in full.

We're betting that our money will do better in the market over the next 10-15 years plus than being used to pay down a low rate loan.

SIS

Several posters have given similar answers- take a loan, but use a large down payment.

What is the reasoning behind this strategy? As I see it, you are either going to have cash negotiating power, or not. A large dp has no effect on that. You are either going to have a mortgage and lien, or not. A large DP has no effect on that. As best I know, the only thing a larger DP gets you is sometimes a slightly better interest rate, and no requirement for mortgage insurance.

Hence, my reasoning is either use cash and get its advantages,, or make the minimum DP necessary to avoid mortgage insurance, usually 20%.

Could you tell me what other concerns you are seeing or responding to?

Ha