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Buying a Home with Cash vs Financing

While buying a home with all cash makes short term economic sense, buying with financing is the only way to build wealth.


All Cash Advantages

Besides avoiding interest payments and transaction fees such as origination fees, appraisal fees, and other miscellaneous costs, purchasing with all cash has compelling reasons to do so.

The reasons cited most often are that sellers prefer the certainty and speed of a cash deal over an offer subject to financing, which creates uncertainty. A cash buyer can often avoid a bidding war with other buyers.


Sellers eager to complete the sale quickly also prefer a cash offer to avoid the usual mortgage-related paperwork and approval process, which enables a faster, more predictable scenario with fewer contingencies. As an example, when a competitive market drives the purchase price above the prices of recently sold market comps, not having an appraisal contingency lowers the risk of the deal falling through due to a low appraised value.


Poor property condition issues or a buyer’s inability to qualify for financing are other good reasons to purchase with cash as well, though alternative financing sources may still be available in these situations.


Mortgage Financing Advantages 

It is rare for a sophisticated property owner to hold real estate for an extended period in cash because advantages gained during the property acquisition are more than offset over time.

Tying up only a portion of capital in one property will increase financial flexibility and liquidity, increasing overall safety (reducing risk) by enabling sufficient liquid reserves needed for emergencies or market downturns.


Leveraging your property accelerates return on capital and promotes overall growth of your asset portfolio, and your wealth. A very significant cost often overlooked by paying cash is the money you don’t make or could have made because your cash is not available to be reinvested.

Borrowing costs are offset by the tax-deductibility of mortgage interest. By my estimate, the interest deduction reduces the interest cost by about the marginal tax rate. Caution: Every borrower is different and since I am not a tax advisor, you should contact a tax professional to see if you could benefit from this.


Borrowing funds serves as a hedge against inflation because inflation causes money to decrease in purchasing power over time. In an inflationary environment, as you make payments to a lender, each payment is less valuable, and since a lender can’t force you to increase the payment to compensate them, they must absorb this cost. Therefore, while inflation increases rental income and the property value over time, it reduces the real cost of holding a mortgage by passing inflation on to the lender. How much of an impact can this really have? A 4% annual inflation rate results in a 39% reduction in the real cost of debt over 10 years. For an analysis of this see my blog post titled “How using debt can counter inflation for the borrower. 


Finally, having a substantial portion of your wealth tied up in a single asset increases exposure to market risks. Diversification is a key principle in risk management, and an all-cash purchase can work against this. For example, should the property be impacted by a natural disaster, such as an earthquake, fire, flood, or tornado, most of the equity can be wiped out.

 

Conclusion

Any advantage gained during the property acquisition process is more than offset over time unless financing is later placed to recover some equity for deployment elsewhere.


The smart strategy for those who can purchase using all cash is to use it temporarily for the purchase, but then take advantage of financing options for the property, post purchase. There are loan products available just for this that reduce the cost of refinancing to take cash out.


Your decision should align with your overall financial strategy, considering factors like liquidity needs, investment diversification, and tolerance for risk.

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