building home...mortgage finance question for expert

[DHonks]

Hey all, I was wondering if anyone was in the mortgage/finance/home sales business and could give me some advice. I'm building a home and wanted advice as to whether to pay for it or get a bank/mortgage company involved.

[DHonks]

bump..okay, not just experts, but I'm looking for advice from homeowners. I have the opportunity to add a home. I have cash set aside. If possible, should I try to pay for it in cash (and avoid interest payments) or carry a mortgage (adds a tax deduction). My thought is that if I have the unique possibility of paying cash, I should. I theorize most have a mortgage because they don't have that opportunity.

 

So my issue is the cost-benefit of paying higher taxes vs paying interest to a bank/lender. thoughts?

[dadofandrew]

There are some benefits to a low interest mortgage, but many of us would give them up in a second to have a home paid for.

[jlau20]

I'm not an expert by any means, but just because you have the money to pay for the house doesn't mean you should necessarily do it. Considering you have enough money available, one option would be to take out the mortgage and invest the rest of the money that you would have spent on the house. It depends on what kind of return you could get, how long you would be willing to leave it invested, etc.

 

If you can figure out what % down payment you would want to do, what the interest payments would be, then you could decide if you'd be able to find an investment that could possibly cover that interest payments and in the end leave you with more money.

 

It's been a little while since I had a real estate class, but if you think about buying (for example) a $200,000 house, fully paid for, it would appreciate at say 4% a year (maybe not right now though with the way things are). Or your other option would be to put $50,000 down on the house and invest the other $150,000 in something else that could possibly return at a higher rate, while your house is still appreciating as well.

 

I probably explained this really poorly, and I know it's not 100% spot-on, but I'd recommend actually talking to a professional about this and seeing if it's something that might work out to your benefit.

[DHonks]

jlau20, my issue is that if I talk to a professional, they'll push me in that direction. I've thought about investing it, but I also want the investment to be guaranteed. So that means an FDIC-insured account or a gov't bond, but not much else is guaranteed. even bank CD's aren't going to sound good right now, given the interest rates.

 

I'm waffling back and forth, hence why I'm asking for advice.

[ewizabeff]

jlau's advice echoes what i've read in most books. If you can make more than the interest you're paying on your mortgage by investing the money somewhere else, go with the mortgage.

 

As we've seen in recent times, even real estate isn't a guaranteed investment. In my family's experience, financial counselors will tell you to do what's best for you - you're paying them a fee anyway, so they don't always have something to gain by recommending certain types of investments for you.

 

Did you say this would be a second house? That's a whole other can of worms as far as taxes go. I'd really recommend ponying up the cash to speak with a professional.

[whizkid]

We don't know much about the rest of your situation so this can only be general. You said 'add a home'. Is this a second home? I think you're single, is that right?

How much your mortgage deduction would benefit you depends on your filing status(i.e. standard deduction amount) and your tax bracket but will be only a part of the interest you pay. Equity in a home isn't liquid. Do you have 6 months or more of living expenses already available? Is your job relatively secure? If you have credit card or other expensive debt, paying that off would benefit you more.

People's situation changes over time, even in a short time. As a general statement, I think I'd put down 20-25% and take out a 15 year mortgage at today's rates to keep some flexibility. You can always start paying additional in a year or 2 and pay it off in 10 years if things are going well. Invest some of the rest longer term, keep some liquid depending on how much liquid assets you already have. You could use some of this to boost your retirement saving rate which would also reduce your taxable income.

Why do you need the investment to be guaranteed? Is that because you can't financially withstand a short term downturn? In that case, I wouldn't tie up all the money in the house either.

[RightFieldCoder]

My unprofessional advice:

 

Pay cash for the house if you can. Put asside money each month as if it were a mortgage into an investment of your choice. (Money market, CD, etc) Garaunteed investments from the bank are going to pay out less than the percentage of the mortgage. Mortgages are where the banks make the money to give back to investors. I think the old advice was based on the assumption that mutual funds "always" return 10% over a long period of time. That's obviously not garaunteed.

 

Mathematically, the advice to invest and take a mortgage is sound. However, math does not take into account emotion or life changes. If something ever happens and you don't/can't make the "mortgage" payment to yourself, you are not in major trouble. All of this advice is dependant on other factors in your life, so don't follow any of our advice. Talk with someone that can see your whole situation.

 

If you do take a mortgage, there is a trick I heard about. Take out a 30 year instead of a 15 year mortgage, but pay every month the same you would have if it were a 30 year mortgage. I don't know the validity of the trick, but it seems sound. The entire extra you pay each month goes towards the principle instead of some of it goinig towards interest if you had a 15 year loan.

 

If you do see a professional, follow Ewizabeff's advice and see a fee only advisor. You pay them a fee for their advice instead of paying commission. The only way for the advisor to make more money is for you to come back for advice or to recomend them to others. This is a great incentive for them to give you honest advice that is in your best interest.

[DHonks]

Some background advice...I still mooch off family and I live rent-free taking care of their vacation home in AZ. So this would be the only home I own. Additionally, I am a teacher, and I will have some job security. My previous position was eliminated, but I was fortunate enough to be placed at a different district school for next year (that's good, given that AZ districts are reducing staffs by 10-15%).

 

I'd want the investment to be guaranteed, because I've seen my IRA cut in half in the last year. While it's rebounded some lately, I'd hate to have the money to pay cash for the house now, but instead I finance it and in 2 years find that I no longer have that ability (if the market continues to be iffy or bad).

 

My thought is that most people would jump at the chance to be done paying for their home...so why would I choose to make payments?

 

Thanks for the other advice though...I'll be sure to look at it more once the game is over!

[homer]

One thing to consider:

Once you pay cash for the house you no longer have that cash. By that I mean you can't access it readily for an emergency (i.e. health situation) or an unforeseen expense (i.e. you get laid off). If you buy the house, the only way you're getting that money out is to borrow it back from the bank or sell your house. So if you do pay cash, I recommend not paying with ALL your cash - keep some for emergencies and what not.

[rluzinski]

Is there such thing as a no risk investment that pays out at 5% or higher? I guess if there's no risk, you take the 30 year fixed mortgage at 5% or lower (with 20% down) and the tax deduction?

[nate82]

Is there such thing as a no risk investment that pays out at 5% or higher?

No such thing exists. If it did exist everyone would be investing in it.

[PeaveyFury]

No such thing exists. If it did exist everyone would be investing in it.

 

Not right now, but just 1.5 years ago CD's and money markets were paying 5-6% almost across the board.

[nate82]

No such thing exists. If it did exist everyone would be investing in it.

 

Not right now, but just 1.5 years ago CD's and money markets were paying 5-6% almost across the board.

I should clarify what I'm talking about here. The no risk investment is what I am referring to as being no such thing that exists. There is always risk involved in investing even in government bonds. There is always some risk to any investment that is made and if there were no risk at all everyone would invest in the product since you would get 100% plus in return of your investment.

 

Money market vehicles have the risks of interest rate changes and inflation, bonds have the risk of inflation, and stocks have interest rate changes inflation and anything else that may change an investors view on the stock. There is no such thing as a no risk investment just what type of risk the investor is willing to take.

[PeaveyFury]

Money market vehicles have the risks of interest rate changes and inflation, bonds have the risk of inflation

 

Well, while you're correct, I think that in this context 'no risk investment' was clearly meaning no risk of loss.

[DHonks]

Right now I'm thinking that perhaps I should pay with around 50% of it, and finance the rest. It gives me cash reserves, but also gives me the mortgage to build credit and the tax benefit. I also may do a 15-year mortgage. Then again, locking in for 30 years at this point in time could be a steal. Depends on what banks will give me

[PeaveyFury]

I also may do a 15-year mortgage. Then again, locking in for 30 years at this point in time could be a steal. Depends on what banks will give me

 

The 'take a 30-year and pay it like a 15-year' strategy that Robin19 mentioned above may make a ton of sense if you're not sure- it gives you flexibility if you can't make the entire payment due to an emergency or something, and have complete control beyond the first 15 years.

[valpocrewsader]

Pay the house off in cash as long as it leaves you with an emergency fund of ~6 months' expenses.

 

Look at it this way, say you take out a mortgage for 50% and pay it off. Once it's paid off, would you borrow against your house to get the cash back so you could do something like invest it? It's virtually the same question. Most people would never borrow against their paid-for house to play some money game and try to eek out an extra couple % hoping everything goes right....