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Should I pay cash or get a mortgage?

By Bob Southard

Real Estate Broker/Owner with Atlas Realty Service, LLC Ga Re lic. 266576

March 14, 2009 07:50 AM

“I was going to pay cash but my financial adviser said to get a mortgage …. I need the tax breaks”

OK, I’ll admit that I don’t have this conversation very often since most of my buyers do not have the choice to pay all cash for their next home. But I have in fact had the conversation a few times.

Not too long ago I had a client who brought up exactly this point. We had an accepted contract on a bank owned home in which the buyer had made an all cash offer.

The client wanted my advice and wanted to know if they could go ahead and get a mortgage even though they had offered cash.

First of all, yes they could obtain a mortgage if they chose to. The fact that the offer was all cash doesn’t mean they can’t get a mortgage. However it does mean that if there would have been any glitches in obtaining the mortgage the seller didn’t care. The buyer would still be expected to close as contracted.

But the real question is why would somebody want to get a mortgage when they could pay cash instead? The answer of course is those mysterious tax advantages. So I asked the client a series of questions. I am a big fan of Dave Ramsey so I was pretty familiar with the questions.

*Your last home was paid off or nearly paid off before you sold it. Did you feel compelled to go get a mortgage to go in to debt on that home? No

*If you were to get a $100,000 mortgage on this new home at today’s rates you pay about $5000 in interest. If you are in a 30% tax bracket you’ll save about $1500 in taxes. Is it worth going in to debt $100,000 to save $1500 per year? No

*Is worth paying $5000 a year to the big monster mega bank mortgage company to avoid giving $1500 to Uncle Sam? No

*(this was my favorite ..) If you gave $5000 to your favorite charity instead of to the big monster mega bank mortgage company wouldn’t get exactly the same tax break? Yes

OK so I’m financial planner or adviser, I’m just the guy you hired to represent your best interests on your home purchase. I don’t really understand why it would be better to go in to debt instead of paying cash! Ultimately the decision is yours but I think your adviser needs to give you a good explanation of why you should get a mortgage.

About an hour later they called back. We decided to go ahead and pay cash for the house.

Under our current tax codes we are allowed to deduct our home interest from our income. But that doesn’t mean we should go in to debt just to get a tax break. And this doesn’t only apply to paying cash. How about paying it off early or getting a 15 year mortgage?

That’s my opinion, How about yours?

Check out the Dave Ramsey Fan Group on ActiveRain

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Bob Southard, e-Pro, Realtor ®, Solid Source Realty, Inc. Buy a home, Sell a home, in Powder Springs, Marietta, Kennesaw, Acworth, Dallas, Hiram,and Cobb, Paulding, Douglas, North Fulton, South Cherokee, County, Ga. Call me for all of your real estate needs.

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Hugh Krone

Weichert Referral Associates - Hamburg, NJ

Realtor, Sussex County NJ

Bob, The only good reason I can think of is in this economy taking a mortage may be risk aversion. If you buy a 100,000 house and take a 90,000 mortgage and next year the economy collapses you go bankrupt ans the house is only worth 40,000 you are out 10,000. If you paid cash your risk liability is much higher.

Mar 14, 2009 08:57 AM

Mike Saunders

Retired - Athens, GA

Bob - Hugh has a valid point. However, I can see one other reason (which I had to make a couple of years ago). It depends upon where you are getting your cash from. I got my cash from the sale of stock that I had accrued. There were capital gains that I had to pay. So, it the buyer had $100,000 in capital gains, even long term, that would be another $15,000 tax liability that year.

Mar 15, 2009 01:04 AM

Kevin Robinson

Twin Falls, ID

Fractional Developer

Mike makes a good point. Your tax liability could take up a huge chunk of your gains.

Mar 15, 2009 02:30 AM

Bob Southard

Atlas Realty Service, LLC - Kennesaw, GA

e-Pro - Cobb,Cherokee,NorthFulton,Paulding,Bartow

Hugh- I see your point. It puts some of the burden of risk on the bank.

Mike - If they sold $100,000 worth of stock they would have some cost basis so the cap gains wouldn't be on the entire 100k. But valid point as well.

Mar 15, 2009 03:38 AM

Donna Harris

Donna Homes, powered by JPAR - TexasRealEstateMediationServices.com - Austin, TX

Realtor,Mediator,Ombudsman,Property Tax Arbitrator

I'm a little confused by your numbers. With the average tax bracket with the example of $100,000, a buyer could have a tax write off of about $250 a month on property taxes and interest alone... $250 a month is a heck of a lot more than $1500 a year. It's still not $5000, but the theory is that the rest of the difference can be made in the market. Maybe not "today's" market, but the average market...

Mar 15, 2009 02:36 PM

Tchaka Owen

Galleria International Realty - Hollywood, FL

Bob - Barring a unique situation (such as the one Mike mentioned), the choice to me is quite easy: he gets the mortgage. You did a good job showing what he'll be paying as well as saving by getting a mortgage, but you left out the opportunity cost of the $100k.

Mar 15, 2009 03:03 PM

Bob Southard

Atlas Realty Service, LLC - Kennesaw, GA

e-Pro - Cobb,Cherokee,NorthFulton,Paulding,Bartow

Donna - $5000 deduction in a 30% bracket is $1500. The prop taxes are still there whether or not there is a mortgage. So the debt does not have an impact on the prop taxes.

Tchaka - I know the opportunity cost is a valid point but I'm not sure that I agree. In a"normal market" whre you could get 10% return on your mutual fund vs paying 5-6% on a mortgage you would make the difference. However at some point there will be tax liablity on the entire 10% and there is also a risk factor by taking on the debt. $100k mortgage has a payment around $600/mo that could be instead invested over time.

To all- I know the logic and convential wisdom is to take out the mortgage. However for most folks I just think they are better off avoiding the debt and living free and clear. Honestly I have very few clients that have this choice anyway. But given the choice I would still advise them to pay cash. Hey, thats just me :-)

Mar 16, 2009 04:30 AM

Nicole Weidauer

Keller Williams Greater Seattle - Shoreline, WA

You know, just as I started to read your blog, Dave came to mind. I couldn't agree more with you. If I ever had the option I would definitely do it!!

For some reason I had never heard of the charity idea. Donate to a charity of your choice and still reap the benefits. Why WOUDLN'T you pay cash if you had it?!

Dave makes so much sense. I am so blessed to have been able to have heard about him and take his advice and apply it to my life. Best thing I've ever done for myself AND my finances!

Thanks for sharing, Nicole Weidauer

The Egerer & Weidauer Team, Keller Williams Realty Greater Seattle

Mar 19, 2009 06:12 AM

Michele Reneau

Certified Staging Professional (CSP) Elite Instructor - Summerville, SC

Realtor, GRI ~ Charleston, SC Relocation Experts Team

Bob-We are personally implementing this in our personal lives. Who says it's not possible. We just sold our primary home that had a big mortgage on it. We still have 3 rental properties the LTV on those are all less than 80%, one close to 50%. We are now renting so that we can save money to pay cash for our next home. I must admit that I have the house itch, but it's good financial planning to be debt free. It's a wonderful feeling not to have debt and it's empowering to pay cash for a nice car and other big purchases. We have more money in savings that I could have ever imagined coming from a blue collar family. It feel great in this economy when things can be tight to have a big cushion. We are about 20% to our savings goal. We are hoping one of our tenants will buy the property they are in which will boast us significantly towards the goal since it's a cash cow. I took Dave's advice to finance it on a 15 yr fixed. It'll be paid off in 7 years or less on our plan. It doesn't make sense to everybody, but like Dave says, live like no one else today, so that you can live like no one else tomorrow. We expect to reach our goal in 4-5 years. The best part is that we won't be making mortgage payments for 15 or 30 years.

Jul 02, 2009 01:22 PM

Bob Southard

Atlas Realty Service, LLC - Kennesaw, GA

e-Pro - Cobb,Cherokee,NorthFulton,Paulding,Bartow

Nicole, thanks for mentioning the charity deductions. You can get the exact same write off by giving the money to your favorite charity as you can by paying the interest. Would you rather give your money a bank or to your church or favorite charity? I know its unconventioanl but for me it's still a no brainer...pay cash if you can.

Michelle, congratulations on making some pretty big steps. No doubt that you will reap big rewards in the future!

Jul 03, 2009 02:48 AM