Putting down more than 20% on your New Home? That might be a mistake
Putting down more than 20% on your New Home? That might be a mistake.
Many Americans believe that buying a home with cash is something only the very rich can do. The fact is however that, in the second quarter of 2014, almost 40% of all the homes purchased in United States were cash deals.
While that may sound like a dream situation to most, the fact is that purchasing a home with cash, and thus not taking on any debt, might not actually be the best way to put your money to work in the long run. Below are three reasons to consider not paying for cash for your next new home, even if you have the cash available. Enjoy.
Reason 1: The loss of your home mortgage interest deduction. One of the biggest benefits of financing a new home is the home mortgage interest deduction that the IRS gives homeowners. What this does is give a homeowner the right to deduct interest paid, up to $1 million, on their first and/or second home, which can be a huge tax savings.
Using a $300,000 home loan as an example, the IRS would give a tax savings of almost $4000 in the first year, money that you would not get back if you had paid cash for your new home. This also lowers the effective interest rate that you have on your home mortgage loan as well.
Reason 2: The loss of leverage from your real estate purchase. When you own real estate you get rights to the full market value fluctuation on that real estate, whether you borrowed 90% to purchase it or paid it completely in cash. Using the same $300,000 home loan from Reason #1 as our example, let’s say that your home appreciated 2% in the first year. That’s $6000 return on your investment.
Now let’s say that your neighbor purchased a similar property for the same amount of money but only put 20% down. That same 2% means they get a $6000 return on their investment as well but, since they only invested just over $80,000 (their $60,000 down payment and 12 mortgage payments), it means they’re actually getting a return of 7.44% compared to your 2%.
The fact is, one of the best benefits of buying real estate is the leverage that you get from doing so, one that’s practically unmatched in any other type of investment. Think about this way; what if you were allowed to purchase stocks with only a 20% down payment, but allowed to keep all of the appreciation that they made?
Reason 3: Paying cash for a new home isn’t the best way to get a return on your money. This one gets a little tricky but still is worth considering. Yes, paying cash for your home means that you’ll pay much less an interest because you won’t have a mortgage. Right now the cost to borrow money is approximately 2.5% and, if you can find an investment that will produce a net return that’s greater than that, you might be better off borrowing money to buy your house and investing the rest of the cash somewhere else.
Simply put, while being able to pay cash for a new home is certainly an achievement worth celebrating, the fact is that there are a number of better ways to use your money to make more money than using it to purchase a house outright.